International accounting standards and practices

Translation Adjustment

Accounting Statement Translation Adjustments for Foreign Subsidiaries

As demonstrated on the attached spreadsheet, when preparing financial statements from a foreign subsidiary of a U.S.-owned company, which will typically conduct business in a foreign currency (the domestic currency of the subsidiary's country of operation), there is a somewhat complex series of adjustments that must take place to account for currency exchange rates during the period covered by the statements. In order to meet current U.S. GAAP standards, the historic rate of exchange -- i.e. The actual rate of exchange at the time of a specific transaction -- must be used, while for other items the current rate of exchange -- i.e. The rate of exchange at the time the statements are being prepared/translated -- is preferred. To complicate things further, at times the average exchange rate for the period as a whole should be used to reflect the value of long-held assets and liabilities. Liabilities are generally translated at current exchange rates, while assets can be translated at historic or average rates. Revenue and operating expenses, which accumulate on an ongoing basis, are best translated using the average exchange rate. This is how adjustments were carried out on the provided spreadsheet, with Cash/Receivables and Supplies multiplied by the historic exchange rates (.2 for January, .16 for December), Property/Plant/Equipment, Revenue, and Operating Expenses multiplied by the average exchange rate (.18), and the remaining accounts were multiplied by the current exchange rate in the scenario (December's exchange rate, .16). In order to bring the accounts back into balance, translation adjustments were subtracted from each date set, also in keeping with U.S. GAAP procedures.

This type of translation allows for the consolidation of accounting statements in a manner that provides real meaning to shareholder and other parties, creating consistent values that represent actual revenues, costs, assets, and liabilities to the firm in a routinized manner. These requirements for the sake of transparency and accuracy in accounting statements, and to prevent opportunities for more nebulous and nefarious foreign currency transactions as a means of "cooking the books." U.S. GAAP and IFRS policies regarding translating foreign accounts have some significant differences, however. Current IFRS policy dictates that assets and liabilities be translated at the closing exchange rate of the date the foreign balance sheet was prepared, while income and expenses are translated at the historic rate -- the rate at the date of the transaction. Instead of a translation adjustment, any resulting imbalance after translation is corrected by recording income (loss) from currency exchanges. In U.S. GAAP procedures, short-term and long-term gains and losses are translated differently, with short-term transactions typically and preferably translated at the historic rate of exchange, recording the real value of the revenue or expenditure as it came into/left the subsidiary, while long-term gains and losses are typically translated current or sometimes average exchange rates depending on other particulars, enabling a more meaningful and reliable valuation.

Many SEC filings demonstrate the process of translating accounts. A simple look at one of the more recent documents filed by Goldman Sachs, the large financial industry and banking company, shows the complexity and the necessity of properly translating accounts. There are, in reality, many areas of flexibility in account preparation and translation, though the guidelines of U.S. GAAP must be followed.

Part 2

The economic exposure to foreign currency exchange that exists for companies with foreign subsidiaries is not necessarily a short-term exposure, but can and frequently does have long-term economic impacts. Currency exchange rates, though volatile, also typically follow long-term trends. The economic environment of a particular country of operation also impacts currency exchange rates to a high degree, and as such economic environments do not tend to change radically in short periods of time the economic exposure must inherently be long-term for ongoing operations. In addition, the ongoing translation of foreign subsidiary documents can lead to the continual adjustment of balances and incomes for those assets, liabilities, and accounts translated at current exchange rates, creating a great deal of long-term economic exposure. Only when transactions are fully cleared or completed do their translated exchange rates tend to become fixed, and thus any long-term transaction opens itself up to long-term economic exposure.