Procedures consolidating foreign subsidiaries
Although the rules on accounting for foreign-currency translations have not changed in many years, mistakes in this area persist. With the increase in foreign transactions comes a parallel increase in foreign-currency reporting, and since many companies do business in multiple countries, the complexity of such reporting is on the rise.Such mistakes can result in misstatements in financial reporting, hurting the bottom line, creating false understandings of business results, and exposing companies to possible regulatory scrutiny. exports are growing at a healthy pace, as a slumping dollar makes goods from the U. The risk of accounting errors in foreign-currency transactions has been compounded by significant volatility in the value of the U. dollar compared with some other currencies, especially in the past 18 months. companies expand their presence in global markets, it is more important than ever to understand and address the most common pitfalls associated with working with foreign currencies.For example, a parent company reporting financial statements in U. dollars that has subsidiaries using the euro and the yen should prepare three statements of cash flows—U. (Click here to download Exhibits 5 and 6, illustrations of the correct and incorrect ways to prepare a consolidated statement of cash flows.) Companies may fail to recognize that they are operating in an economy that has become highly inflationary, and hence do not appropriately modify their accounting for foreign-currency translations. GAAP, the financial statements of the foreign entity operating in a highly inflationary environment are required to be remeasured as if the functional currency were the reporting currency, which generally results in translation adjustments’ being reported in earnings currently and requires that different procedures be used to translate nonmonetary assets and liabilities. THREE WAYS TO MITIGATE THE RISK OF MISSTATEMENTCompanies can reduce the risk of misapplying the accounting rules for foreign-currency translations and, in turn, misstating the financial statements, by taking these three steps: U. companies operating in foreign countries should develop and adhere to a strong companywide policy on the translation of intercompany accounts.Essentially, they continue to recognize currency translation adjustments in OCI and continue to translate all assets and liabilities at current translation rates. An example of this is Venezuela, which reached highly inflationary status for U. In other words, a company should have clear guidelines that lower-level accounting personnel can follow easily. GAAP also use different nomenclature for foreign-currency matters. Click here to download detailed examples of Mistake 2.Therefore, the German subsidiary must adjust its liability to Parent Company A from €6,961,000 to €7,433,000.The subsidiary will credit its liability for €472,000.Such a misclassification sounds benign, but it misstates net income and hides the gain or loss in an account that is normally presented as part of the statement of changes in equity.This mistake can arise when a company has an intercompany account (for example, a parent’s intercompany receivable from a subsidiary) recorded on the books of companies with different functional currencies. On that date, Parent Company A records a million receivable on its balance sheet, and the subsidiary records €6,961,000 on its balance sheet. Now assume that no other entries are recorded to this account, but that on March 31, 2011, Parent Company A must report its financial statements.
This mistake occurs when a company misclassifies a foreign-currency gain or loss in OCI instead of net income.
A key factor raising the stakes in foreign-currency reporting is the fact that U. companies are increasingly looking offshore for growth. And this volatility will likely continue, given recent headlines, such as the spike in the yen’s value following Japan’s devastating earthquake last March, the rise of China’s yuan to a new high versus the U. dollar last summer, and runaway inflation in developing countries such as Venezuela. This article examines three frequent mistakes that accountants make regarding the reporting of foreign currencies.
Avoiding these pitfalls can make a big difference to companies’ financial statements.
Exhibit 3 shows an example of the translation of a subsidiary operating in a foreign functional currency under the proper accounting, while Exhibit 4 shows an example of the common mistake.
In these examples, a parent company lent million to a subsidiary whose functional currency is the euro.