Although the rules on accounting for foreign-currency translations have not changed in many years, mistakes in this area persist. Such mistakes can result in misstatements in financial reporting, hurting the bottom line, creating false understandings of business results, and exposing companies to possible regulatory scrutiny.

A key factor raising the stakes in foreign-currency reporting is the fact that U. With the increase in foreign transactions comes a parallel increase in foreign-currency reporting, and since many companies do business in multiple countries, the complexity of such reporting is on the rise.

The risk of accounting errors in foreign-currency transactions has been compounded by significant volatility in the value of the U. THREE COMMON MISTAKES As U. This article examines three frequent mistakes that accountants make regarding the reporting of foreign currencies. Hiding foreign-currency gains and losses in other comprehensive income OCI instead of recognizing them in net income. This mistake occurs when a company misclassifies a foreign-currency gain or loss in OCI instead of net income.

Such a misclassification sounds benign, but it misstates net income and hides the gain or loss in an account that is normally presented as part of the statement of changes in equity. The issue boils down to how to account for an intercompany balance when each of the parties has the balance recorded in different currencies for example, the parent company records the balance in U. To illustrate, assume that on Jan. Now assume that no other entries are recorded to this account, but that on March 31, , Parent Company A must report its financial statements.

The question is how the German subsidiary should record the offsetting debit to this transaction. The common mistake is to record the debit side of this transaction as part of the currency translation that is included in OCI.

Generally, the debit side of this transaction should be included in net income rather than only as a component of OCI. There is one exception to the general rule, however. Foreign-currency gains and losses on intercompany accounts that are essentially permanent are excluded from the determination of net income and instead are recorded as OCI.

In essence, if the intercompany account is essentially a permanent investment in the subsidiary, the gain or loss on that account should be excluded from net income.

Unless the intercompany account meets this narrow exception, foreign-currency gains and losses on intercompany accounts should be included in determining net income. Normal intercompany accounts will generate a gain or loss that is ordinarily reflected on the books of the subsidiary operating in a functional currency other than the reporting currency of the parent company. This gain or loss will not be eliminated in consolidation. This point seems counterintuitive and could be at the root of many errors in this area.

Exhibit 3 shows an example of the translation of a subsidiary operating in a foreign functional currency under the proper accounting, while Exhibit 4 shows an example of the common mistake. As you compare Exhibit 3 to Exhibit 4 , notice how subtle the error can appear. Preparing the consolidated statement of cash flows based on amounts reported in the consolidated balance sheets.

Summary of Statement No. 52

The second common mistake is misstating the statement of cash flows by allocating changes in cash flows from the effects of foreign-currency rates among individual cash flow line items. GAAP requires that the statement of cash flows present changes in cash flows at the rate in effect on the date the cash flows took place, although the rules permit use of the average rate in effect during the period if it reasonably approximates the timing of cash flows. The issue is that many preparers present the statement of cash flows under the indirect method.

When preparing the statement of cash flows for a consolidated company that deals in more than one functional currency, it is simple to prepare a statement of cash flows based on the consolidated balance sheets of the current and prior periods—simple, but not correct. The consolidated balance sheets have been prepared using the exchange rates in effect on each balance sheet date; cash flows, however, should be translated into the reporting currency using the average exchange rate in effect during the period.

The differences between those rates can be significant. The right way to prepare a consolidated statement of cash flows requires a bit of work. The statement should be prepared using cash flow activity at the functional currency level that has been translated to the reporting currency using the average exchange rate in effect for the period.

Foreign Currency Gains and Losses - Zuora

For example, a parent company reporting financial statements in U. The statements prepared in euros and yen for each of the subsidiaries would be translated into U. Click here to download Exhibits 5 and 6, illustrations of the correct and incorrect ways to prepare a consolidated statement of cash flows.

Failing to recognize the need to modify accounting for foreign-currency translations in highly inflationary environments. Companies may fail to recognize that they are operating in an economy that has become highly inflationary, and hence do not appropriately modify their accounting for foreign-currency translations.

Essentially, they continue to recognize currency translation adjustments in OCI and continue to translate all assets and liabilities at current translation rates.

An example of this is Venezuela, which reached highly inflationary status for U. GAAP purposes effective Nov. On that date, a U. The subsidiary would remeasure assets and liabilities into U. Going forward, the subsidiary should measure monetary assets and liabilities at current that is, balance sheet exchange rates and recognize a gain or loss on that translation in net income. This diverges significantly from the rules prior to the application of highly inflationary accounting where such gains and losses would be recognized only in OCI.

Adopt understandable accounting policies. In other words, a company should have clear guidelines that lower-level accounting personnel can follow easily. Global companies also should ensure that each accounting system used to perform consolidation procedures handles the processes in compliance with U.

Ideally, the system will allow users to see a clear trail of foreign-currency translations that can be tracked back from the financial statements.

Implementing adequate internal controls. Global companies also should implement internal controls designed to analyze and detect misstatements in foreign-currency gains and losses. These controls should analyze accounts included in net income and the translation account included in OCI. GAAP The three mistakes discussed here can occur regardless of whether a company applies IFRS or U.

GAAP could affect the mix of functional currencies used by global companies. The substantive differences between IFRS and U.

Once an entity is determined to be operating in a highly inflationary environment, IFRS and U. IFRS uses an approach that restates historical amounts potentially including the prior-year comparative amounts into their current value, using end-of-period rates. GAAP, on the other hand, dictates that the entity adopt the reporting currency as its functional currency.

Upon selecting a functional currency, IFRS identifies primary and secondary factors to consider. GAAP also lists factors for consideration in selection but assigns equal weight to them. When a company changes its functional currency, IFRS always accounts for the change prospectively. GAAP, however, in certain circumstances requires retrospective application of the change. GAAP also use different nomenclature for foreign-currency matters.

Click here to download detailed examples of Mistake 2. Foreign currency is playing a bigger role in financial reporting as U. Companies participating in foreign markets should be aware of three common mistakes in accounting for foreign currency. They are hiding foreign- currency gains and losses in other comprehensive income rather than recognizing them in net income; preparing the consolidated statement of cash flows based on amounts reported in the consolidated balance sheets; and failing to recognize the need to modify accounting for foreign-currency translations in highly inflationary environments.

Companies can reduce their risk for misapplying the accounting rules for foreign-currency translations in three main ways: Companies need to stay on top of foreign-currency-translation accounting. To comment on this article or to suggest an idea for another article, contact Kim Nilsen, executive editor, at knilsen aicpa. For more information or to place an order, go to cpa2biz. Management accountants in the United States face significant challenges as companies prepare for the far-reaching change.

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This quick guide walks you through the process of adding the Journal of Accountancy as a favorite news source in the News app from Apple. Toggle search Toggle navigation. All articles IFRS Internal control Private company reporting SEC compliance and reporting U. Three common currency-adjustment pitfalls How to correctly account for foreign-currency translations BY SCOTT L. SPENCER, CPA AND GLENN E. TOPICS Accounting and Financial Reporting Management Accounting Corporate Finance and Treasury Management.

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