Currency translation is a relatively modern requirement for global business. The Spanish silver dollar ruled the world as a single global currency for more than 200 years and Spanish coins cut into “pieces of eight” remained legal tender in the United States until 1857.
The point of this history lesson is to throw the modern currency paradox into sharp focus: The greater your global reach, the less you tend to know about your financial position. In addition to making it difficult to adhere to fiduciary responsibilities and legislative requirements, a lack of control over currency translation makes it difficult to adequately assess cash flows, TCO and profitability. This is vital as organisations face increasing pressure to fulfil customer demand and compete in an ever more global marketplace.
The steps listed here will help organisations streamline foreign currency processes.
Translate income statements with your preferred standard
IFRS and GAAP are converging but the differences remain significant and become evident in regions where inflation is high or whenever there is a change to the functional currency. Two of the biggest differences that trip up accountants are that LIFO is not an option under IFRS, and GAAP demands that development costs should be expensed as incurred, unless you are developing software and under other specific conditions. PwC created a very useful IFRS/GAAP translation guide covering updates and differences.
Document policies and train your team
This step is not as simple as it sounds. Employees and contractors must adapt to specific accounting policies and be able to consistently apply principles that may vary from their initial training. This is especially true when organisations operate in different countries and use different rules. It is vital to document all accounting policies, train stakeholders adequately and ensure management has the necessary tools to evaluate financial data according to these policies.
Record gains and losses as Net Income, not Other Comprehensive Income
This simple change in initial recording prevents a host of problems occurring later. For example, net income will be off, and any gain/loss will be held in an account that normally only appears as part of the Statement of Changes in Equity. Gains or losses due to foreign currency translation need to be considered as net income. And if accounts aren’t aligned, gains/losses can’t be addressed in the final consolidation.
Make sure processes are transparent
Having visibility into the entire process, regardless of the currency used and who or where the financial statements are produced, is vital. The audit trail and reconciliations should enable users to drill down deeply into report data. And it is important to establish how specific accounts/results were translated, adjusted and consolidated.
Use the right translation method for financial statements
There are two main translation methods, namely temporal or current rate; which is used is based on the local region. So, if the region is undergoing hyperinflation, the temporal method is more accurate as it captures the value of the transactions at the time they occurred. However, finance professionals are more comfortable using the current rate method.
Asset and liability accounts should be translated at the current rate, while historical exchange rates apply to equity items. Income statement items are translated using a weighted average exchange rate.
Use the appropriate exchange rates for each period
Before consolidation, translate cash flows into the reporting currency using exchange rates that were in effect during that period. This is where mistakes are made easily.
Many prepare consolidated statements of cash flows just as they would for local businesses, tending to pull in information from consolidated balance sheets. The result is that they are, by default, using exchange rates that were current on the date of the balance sheet.
Cash flows must be prepared using functional currency activity translated into reporting currency, with the appropriate time-period specified for the relevant exchange rates.
Build automated safeguards into month-end reports
While saving time and money and improving the quality, accuracy and reliability of critical information, software should also reduce the margin for human error as it automates data input, reconciliation, control and reporting processes.
Prepare for what’s next with what-if analysis
The ability to respond rapidly to change is fundamental for businesses. Advanced software delivers better planning, forecasting and more complex financial scenarios that can handle more variables. In addition, it delivers data that complies with differing accounting principles and meets regulatory and legislative requirements.
Explore hedges to foreign exchange risk profiles
The three main risks in foreign currencies are economic, transaction and translation exposure. It’s possible to limit economic or long-term cash flow exposure by risk-sharing agreements and currency swaps.
Hedging transaction exposure can involve forward deals to lock in specified exchange rates. While translation exposure has to do with the true cross-market value of assets, liabilities, equities and income is based on local currency fluctuations. In this case, there is considerable debate over whether to hedge these risks or not. Before deciding, it is important to evaluate if it is worth it if it weakens cash position.
Faster, more reliable numbers
Traditionally foreign currency translation, determining profitability and meeting reporting requirements were time-consuming. As organisations extend global reach, they need better data on asset security, economic stability in host countries and productivity for supply chain partners. Advances in technology, digitalisation and cloud based software enable financial leaders to manage these demands effectively to ensure they can deliver a more complete financial picture of foreign operations with shorter turnarounds.