By Chrissy O’Hara CPA, CFO at SoftLedger.
The end of December can be a stressful time for accountants and business owners facing their fiscal year end. It’s time to focus on finalising financial records, year-end tax planning, and preparing for audits and compliance deadlines. That means taking care of all the messy details left hanging throughout the month, quarter and year.
One of the thorniest is multi-currency accounting, which includes remeasurement and translation. Every entity that transacts in a currency other than their own (i.e. functional currency) is required to go through remeasurement. Remeasurement is the process of revaluing any account balance or transaction denominated in a foreign currency to the appropriate amount in the organization’s functional currency. It’s not just a “nice to have,” it’s required for GAAP and IFRS financials.
The other process is translation. While remeasurement is focused on transactions, translation is focused on financial statements. In translation, the goal is to display the consolidated company in the parent’s functional currency so the reader has an accurate picture of the company’s financial position. Any entity with a functional currency that differs from their parent entity’s functional currency must go through this second process.
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By breaking these processes into clear steps, multi-currency accounting can be accomplished smoothly. If things start feeling complicated, it’s important for companies to step back and remember which step they are focused on rather than getting lost in the weeds.
Step One: For Remeasurement, Consider Transaction Timing
Every entity that transacts in a currency other than their own needs to remeasure each multi-currency transaction. Remeasurement’s goal is to ensure that every transaction is translated to the appropriate functional currency amount (USD, for example, if an organization is headquartered and operating in the US). The first variable to consider is when the actual transaction occurred. Every transaction occurring in a different currency should be remeasured to USD at the point in time the transaction occurs.
If the transaction was settled on the same day it was initiated (ie, there was never an outstanding accounts payable balance), simply multiply the foreign-denominated amount by the exchange rate on the transaction date to get the amount in your functional currency. However, if the entity enters into a transaction and doesn’t settle the transaction for weeks or months from when the price was stated in the other currency, then remeasurement occurs at the date of the transaction, and each month-end reporting period for the outstanding balance, taking into account changes in the exchange rates that have occurred since the transaction date.
Let’s walk through a short example. Suppose a US based company agrees to pay a vendor in the UK 100 pounds on 12/15/X1. The contract and bill are denominated in pounds. On 12/15/X1 the exchange rate is 1:1 USD/GBP. The company pays it on 12/15/X1 and books an expense for $100 and cash payment of $100.
Suppose instead the company waits to pay it on 12/31/X1 when the exchange rate is now 1:1.1 USD/GBP. The company now owes $110 to your vendor due to exchange rate fluctuations. The additional $10 goes through your P&L as a foreign currency exchange loss and impacts its net income.
Step Two: Determine Proper P&L Reporting for Remeasurement
Remeasurement is required for all assets and liabilities, which are split into two categories: monetary and non-monetary. Non-monetary items include PPE (property, plant and equipment) and equity. Monetary items include cash, receivables and payables. The way remeasurement works is a little different for the two categories.
- Monetary: Transactions remeasured at the time of the transaction and open balances must be remeasured every period. Exchange rate fluctuation does result in gains or losses on the P&L. These are liquid assets and liabilities: cash, money owed vendors, money customers owe, etc..
- Non-Monetary: Transactions remeasured at the time of the transaction and open balances ARE NOT remeasured every period. Exchange rate fluctuation does NOT result in gains or losses on the P&L. These are illiquid assets and liabilities: PPE, equity contributions from a parent entity, etc
Step Three: Tackle Translation
Any entity in a consolidated group (multi-entity structure) with a functional currency different than that of its parent entity has to go through translation. This step is entirely separate from remeasurement and only necessary for consolidated companies that have more than one functional currency within the consolidated group.
Translation is not about going back in time and pretending the parent’s reporting currency was used in every transaction of its subsidiary. It’s to show the assets and liabilities of the whole company in one currency accurately as of a point in time. The only accounts that use historical rates are equity accounts, including retained earnings, since those are part of the consolidated company’s historical net asset value (and because otherwise the parent’s investment in its subsidiaries will not net out to zero).
Translation of an entity’s financial statements will result in a Currency Translation Adjustment (CTA) on the balance sheet of the subsidiary that was translated. The CTA is calculated as the difference between the rates used for historical line items vs. weighted average vs. spot rates. It will always be equal to the difference between assets and liabilities after all other line items have been translated.
There is some added complexity if there are transactions between related parties or between a parent and subsidiary with different functional currencies. For purposes of translating and consolidating, the parent must apply the transactional specific exchange rate to get the intercompany transactions to eliminate.
Set Up Best Practices for Next Year
Putting a year long set of rules in place can help make next year’s multi-currency process. For small to mid-sized companies, the best way to reduce issues with exchange rates is to pay as soon as possible – ideally on the same date as a charge or invoice is received. When cost is calculated in another currency, it is going to be when the functional currency and transaction currencies are as closely related to one another as possible. Waiting days, weeks or months creates disparity between the two currencies and results in extra calculations and possible losses. Only large companies with teams focused on hedging exchange rates should deviate from this rule.
Second, companies should always try to negotiate contracts in the currency that business operations are in. If a company only has USD bank accounts and operates in the US, try to negotiate any transaction with a foreign vendor or customer in USD. That would eliminate foreign exchange loss exposure and minimize additional steps in the month-end close process.
Lastly, ensure functional currencies are set deliberately and an organizational structure is in place that is compliant with the accounting codification a company adheres to prior to engaging in transactions denominated in foreign currencies. Switching functional currencies or carving out foreign operations retrospectively is an extremely expensive and time-consuming task.
Creating clear, repeatable rules for multi-currency accounting will ensure less headache and more accuracy moving forward.
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Tags: Accounting, multi-currency, multicurrency, Technology
