Foreign Currency Translation

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Meaning and definition of Foreign Currency Translation

Foreign currency translation is about converting the figures related to accounting stated as per one particular currency to another currency to meet the finance reporting related requirements. As per the United States Generally Accepted Accounting Principles regulations, the items in the balance sheet are converted in accordance with the rate of exchange as on the date of balance sheet, whereas items in the income statement are converted in accordance with the weighted-average rate of exchange for that particular year. The losses and profits that are derived as a result of the converting are showcased in the equity category of the owner in the form of a separate item.

Besides, the profits and losses occurring from the conversion are disclosed as a separate item in the owner’s equity section. Moreover, any material change in exchange rate occurring during the period from financial statement date to the audit report date is presented in the financial statement that follows the specific period. 

The International Accounting Standard 21 ‘The Effects of Changes in Foreign Exchange Rates’ lays down the manner in which foreign currency transactions as well as operations should be accounted in the finance related statements. It also suggests the manner in which statements should be translated into a presentation related currency. A company needs to find out a currency that is functional on the basis of the economic environment in which it is operating and usually records currency related transactions utilizing the spot rate of conversion on the date when the transaction is conducted.

Steps involved in the translation process

The process of foreign currency translation involves the following four steps:

  • The first step involves matching the financial statements of the foreign country to US GAAP.
  • The next step is determining the functional currency of the foreign entity.
  • Re-assess the financial statements in the functional currency, if required. Profits and losses arising from the re-assessment are countable in re-assessed current income.
  • Thereafter, the foreign currency is converted into the required currency, like US dollars.

A transaction that involves foreign currency must be registered initially as per the exchange rate applicable on the transaction date. Thereafter, at every balance sheet date that arises subsequently the amounts pertaining to foreign currency must be reports utilizing the rate of closing. The differences arising in exchange at the time when the monetary items are translated or when they are adjusted at different rates, from the rate at which the items were converted at the time of being recognized initially, or in the previous statements are record in loss or gain in the cycle, with just one single exception. 

Important considerations about foreign currency translation

There are certain points that demand consideration during the process of foreign currency translation. These are:

  • If the functional currency of a company is a foreign currency, the translation adjustments come up by translating the financial statements of the company into the reporting currency.
  • Translation adjustments should not be included in the income statement for being unrealized but should be presented separately and added in separate component of equity. However, if re-assessment from the recording currency to the functional currency is requisite before translation, the profit or loss is replicated in the income statement.

Upon liquidation or sale of an investment in a foreign entity, the amount attributable to the concerned entity and added in the translation adjustment component of equity is eliminated from equity section of the stockholder and is considered as a part of the profit or loss on liquidation or sale of the investment in the income statement for the period of occurrence of sale or liquidation. 

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