ACT504 Chap.10 Translating Foreign Currency Financial Statements
Translating Foreign Currency Financial Statements
One decision drives the whole method
The published indicative content names functional currency, the closing and temporal rate methods, and sustainability risks and opportunities across the consolidated group structure.
The functional currency is the currency of the primary economic environment in which the entity operates: the one that mainly determines its selling prices, its labour and material costs, and the currency in which its funds are generated and retained.
It is a fact to be established from the circumstances rather than a policy to be chosen, and once established it decides everything else.
Two translations, and what each one preserves
Translating foreign amounts into the functional currency treats them as transactions the entity itself entered into, so it preserves historical cost: a non-monetary asset bought years ago keeps the rate of the day it was bought, and its depreciation keeps that same rate, because both describe one past event.
Translating a complete set of statements into a different presentation currency is a restatement of accounts that are already complete, so it preserves relationships within them: every asset and liability moves at the closing rate and income and expenses at transaction or average rates, which keeps the statements internally consistent in the new unit.
The row that behaves the same in both columns
Monetary items, meaning cash, receivables, payables and borrowings, take the closing rate under either translation, because a monetary item is a right to receive or an obligation to pay a fixed number of currency units and what it is worth today depends only on today's rate.
Every row that differs between the two translations is a non-monetary row, and they all differ for the same reason: one column is preserving a past cost while the other is restating a present balance.
Two differences with the same name and different homes
A difference arising when a foreign balance is brought into the functional currency is a gain or loss the entity has genuinely experienced, so it goes through profit or loss.
A difference arising when a finished set of statements is restated into the presentation currency is an artefact of the restatement rather than an event, so it goes to other comprehensive income and accumulates in a translation reserve inside equity.
That is the same translation gain that appears as a component of comprehensive income in the consolidation chapters, and it is why a group with foreign subsidiaries carries such a reserve at all.
Verify the adjustment rather than plugging it
The exercises ask for the translation adjustment to be verified as a separate step, which is the signal that a balancing figure is not an answer.
It can be computed independently from the movement in rate applied to opening net assets plus the period's result at the difference between the average and closing rates.
Agreement between the independent computation and the balancing figure confirms both; disagreement means the error is elsewhere and the plug has hidden it.
Sustainability across the group structure
The indicative content attaches sustainability risks and opportunities across the consolidated group structure to this topic, and the link is the group boundary rather than the exchange rate.
Exposures arising in a foreign subsidiary are the group's to report because that subsidiary is inside the boundary drawn by control, even though it files its own statements locally under its own rules. The reporting problem has the same shape as the translation problem: a complete set of facts prepared on one basis has to be restated onto the group's basis before it can be presented.
What this chapter covers
- 01
Establishing the functional currency from prices, costs and financing
- 02
What translation into the functional currency is trying to preserve
- 03
What translation into a presentation currency is trying to preserve
- 04
Why monetary items take the closing rate under either method
- 05
The rate that attaches to plant, to its depreciation and to inventory
- 06
Two translation differences, one in profit and one in equity
- 07
Computing the translation adjustment independently of the balancing figure
- 08
Group-wide sustainability reporting and the boundary that defines it
Translate plant and inventory under each assumption
- 3Translate the two balances on the first assumption, naming the rate used.
- 3Translate them on the second assumption.
- 1State where the difference is recognised in each case.
Key terms
- Functional Currency
- The currency of the primary economic environment in which an entity operates, determined by what drives its selling prices, its costs and its financing. It is established from the facts rather than chosen.
- Presentation Currency
- The currency in which a group presents its financial statements. Where it differs from a subsidiary's functional currency, the complete statements are restated into it.
- Closing Rate
- The exchange rate at the reporting date. It applies to all assets and liabilities when restating into a presentation currency, and to monetary items under either translation.
- Monetary Item
- A right to receive or an obligation to pay a fixed number of currency units, such as cash, receivables, payables and borrowings. Its value depends only on today's rate, so it always takes the closing rate.
- Translation Adjustment
- The difference arising on restating a complete set of statements into a presentation currency. It is recognised in other comprehensive income and accumulates in a translation reserve within equity.
Translating Foreign Currency Financial Statements FAQ
How do I decide the functional currency?
From the economic facts rather than from where the parent is. The functional currency is the currency of the primary economic environment in which the entity operates, which means the one that mainly determines its selling prices, its labour and material costs, and the currency in which its funds are generated and retained.
A subsidiary that sells locally, pays local wages and borrows locally has the local unit as its functional currency even if every share is held abroad and the group reports in another currency.
Why does the same asset end up at two different amounts?
Because the two translations answer different questions and preserve different things. If the group's currency is functional, the asset is a transaction the entity entered into in a foreign currency, so historical cost is preserved at the rate on the date it was acquired. If the local unit is functional, the asset is an ordinary local asset and the whole statement is restated at the closing rate.
Neither answer is wrong; establishing the functional currency is the step that chooses between them.
Exam move
Rule two columns on one page, headed by the two translations, and run six lines down them from memory: plant, its depreciation, inventory, receivables, sales and share capital. Then write one sentence under each column saying what it is preserving. The table is small enough to reproduce in an examination margin, and the two sentences are what let you reconstruct any row you cannot recall.
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