Continuing our previous post on currency accounting, we’ll now move onto translation and revaluation as it relates to accounts and controls.
Revaluation doesn’t just impact accounts payable and receivable. It also impacts foreign currency bank accounts and/or intercompany payables and receivables. The challenges with these accounts are often more system-based than conceptual. Most accounting systems that can handle foreign currency can track the currency and initial rate of payables and receivables. Because most systems require complete information for transactions these transactions are generally entered with complete information (you can’t print an invoice/cut a check if you don’t specify the currency correctly), revaluation is usually fairly smooth.
Bank accounts can be more of a challenge. Accountants unaccustomed to working with different currencies often take short cuts when doing account reconciliations. They reconcile their financial statements, but they don’t always reconcile the foreign currency balance. Some systems have the ability to insist that currency is always entered correctly but too often these controls are not properly set up. Here are a few tips to help avoid problems:
1) If you have to revalue and you have accounts with transactions in multiple currencies, set up sub accounts for each currency involved.
2) Setup system controls as tightly as possible. Make your end users enter the proper currency information with every transaction.
Balance Sheet or Income Statement?
In our example above, we treated the gain/loss as an income statement item. This will be the case for most accounts you revalue. The general rule (and, again, please check with your accountants) is that any asset or liability that you expect to settle within a set amount of time (such as payables and receivables) should be revalued to the income statement. If you have liabilities or assets like intercompany payables/receivables that you don’t expect to settle quickly, the revaluation should hit the equity section of your balance sheet. The ability to determine the appropriate account is often not allowed through software packages. Often, we can work around these shortcomings with reports.
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So far what we’ve covered applies to companies that do business in other currencies but the company itself (and all its legal entities) still operates in a single currency. When you have legal entities in multiple jurisdictions with multiple currencies, you need to perform currency translation. Currency translation is the process by which we take foreign entities and “translate” their financial statements into the currency of the parent entity.
Let’s take an example of ACME Manufacturing. ACME has entities in the U.S. (reporting in USD) and entities in the U.K. (reporting in GBP). The UK/GBP entity must close its books in GBP and then “translate” them to USD for consolidation purposes. (See our series on consolidation for more information.)
To do this, you have to take the financial statements and apply the appropriate translation rate to each account. The difference is then posted to the equity section of the balance sheet as “foreign currency translation.”
Generally, rates are determined as follows:
- Income statement accounts are translated at the average rate for the period.
- Liability and asset accounts (with the exception of fixed assets) are translated at the ending rate for the period.
- Fixed asset accounts are translated at the original historical rate at which they were acquired. This means that in most accounting systems, the translated rate is calculated when the entry is created and is never “retranslated” again.
- Equity accounts are generally not revalued.
Naturally, you’ll want to review your setup to ensure you conform to standard GAAP. Our goal here is simply to explain your options.
To illustrate, let’s start with some basic trial balances for ACME Widgets and its U.K. affiliate. To make things easy, I’ve set it up so there are no intercompany accounts to eliminate. Debit balances are positive numbers, credit balances are negative numbers.
|Rate Type||Rate||ACME UK
|US and UK (USD)|
|Accounts Receivable||25,000||10,000||Period End||1.6||16,000||41,000|
|Accounts Payable||-30,000||-15,000||Period End||1.6||-24,000||-54,000|
|SG & A||10,000||5,000||Per Average||1.7||8,500||18,500|
|Occupancy Cost||5,000||2,000||Per Average||1.7||3,400||8,400|
After all the translations are performed, the offsetting balance is posted to currency translation. It resides in the equity section of the balance sheet.
In our next blog post, we provide a few additional pointers to help your currency accounting run smoothly. And let us know if you’re looking for BI Consulting or a Microsoft SSRS Consultant.