While many people are worried about the future of the single European currency, there’s a completely different problem thrown up by the fact that it hasn’t got a history. Come the launch of the euro, companies throughout Europe will be looking to report their financial results in the new currency. But how do they report the figures for prior years such as 1998? Converting deutschemark, French franc or sterling accounts into euros for a financial period in which the euro did not exist presents unique problems. The European Commission’s DGXV solution is this: prior period figures should be translated at the rate at which the national currency converts into euros on 1 January 1999. But there’s a problem: if financial results for periods after that date are translated at the average euro exchange rate for the period, then comparability will be seriously damaged if results for periods prior to 1999 are all translated at the 1 January 1999 conversion rate. However, the European Commission has decided that it isn’t appropriate to use the Ecu exchange rate for periods up to 31 December 1998, even though the Ecu will convert to euros on a strict one-for-one basis on 1 January. The EC opposes this idea because the Ecu is a “basket” of currencies, not all of which are converting into euros. Sterling is the prime example, along with the Danish krone and Greek drachma. (The EC has also said it’s not appropriate to use a “synthetic” euro rate, because of difficulties in defining exactly what that rate should be.) But to see how illogical the EC’s argument is, consider example 1 (right). Take a British company that has flat annual sales of £100m. In 1999, 2000, 2001 and beyond it would translate that £100m at the average E/£ rate for each year. The result is a euro-denominated revenue line which fluctuates because of the volatility of the exchange rate. But for 1996, 1997 and 1998 – or any other prior period – the company is supposed to convert annual revenues using the initial 1 January 1999 exchange rate of E1.45 (say). So for those three years, turnover will be flat at E145m. The transition from a flat sales line to one that subsequently fluctuates with the E/£ exchange rate makes little sense. If, as in example 2, the prior periods had been converted into Ecus – not euros – at the average rate for each year, then the sales line would look much different. Not convinced? Try example 3. Imagine a British company which has always reported in sterling, but which makes all of its sales to the EC and thus its products and services are all priced in Ecus. If it makes annual sales of Ecu100m, then the turnover line for the last three years would have been converted into sterling at relevant Ecu/sterling exchange rates for each period. After 1 January 1999, its sales will be denominated in euros, and translated into sterling using relevant euro/sterling rates. From 1999 onwards, those sterling financial reports will be reported in euros by using the relevant euro rate. But all prior periods have to be translated using the euro/sterling rate on 1 January 1999. This gives the bizarre situation whereby 1998 sales of Ecu100m get reported initially as £67m, but translated into euros as E97m. The reason it’s bizarre is the one-for-one convertibility of Ecus into euros: 1998 sales of Ecu100m get reported as prior year sales of E97m – even though those Ecu100m may be legally collectible in 1999 as E100m.
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