If your business carries out foreign operations or trades in foreign currencies, you understand the complications that may arise in the accounting arena. You need a consistent method to translate accounting items from the functional currency to the reporting currency.
The International Accounting Standards Board requires a consistent currency translation method to ensure accurate financial reporting and international tax liability determination.
According to the International Accounting Standards, the functional currency matches the entity’s primary operation environment. The reporting currency is the one in which the company presents its financial statements.
There are two methods for translating a functional currency into a reporting currency: current-rate translation and temporal rate translation.
Current-Rate Translation Method
The current-rate translation method is ideal if the subsidiary is mainly independent of the parent company’s activities. It also applies where the functional and local currencies are the same.
With this method, the entity translates assets and liabilities at the current exchange rate. The company will also report gains or losses that result from this transaction on a reserve account (not the consolidated net account).
Reporting gains or losses on a reserve account is necessary to absorb the perpetual volatility of the exchange rate. Excluding gains or losses that result from a currency translation from consolidated earnings also makes it easier for stakeholders to evaluate the company’s performance on an accounting level.
Current-rate currency translation takes place in three steps:
- Income statement translation using the weighted-average exchange rate
- Asset and liability translation at the current exchange rate
- Rebalancing the balance sheet
Temporal Rate Translation Method
The temporal, or historical, translation method is ideal if the functional and local currencies differ.
With this method, the entity bases the exchange rate value on the time it acquired the asset or incurred the liability.
Monetary asset and liability conversion let the entity use the exchange rate that is in effect on the balance sheet date. However, when converting non-monetary assets and liabilities, the company uses the exchange rate at the time of the transaction.
The temporal rate translation method is best used to show that the net earnings reflect the gains and losses from the currency translation.
MKS&H is a leading provider of international tax and accounting services. Our team has extensive experience in meeting the tax and accounting needs of foreign-owned US subsidiaries.
We can also help these entities with relevant accounting standards and tax legislation.
Contact MKS&H today for an initial consultation.