Question

Discuss in detail the conceptual issues related to translation of foreign currency financial statements.

Answer 1

The two major issues related to the translation of foreign currency financial statements are:

1. Choice of method-The first issue relates to determining the appropriate exchange rate (historical, current, or average for the current period) for the translation of foreign currency balances. Those items translated at the current exchange rate are exposed to translation adjustment.

Translation methods differ on the basis of which accounts are translated at the current exchange rate and which are translated at historical rates. Accounts translated at the current exchange rate are exposed to translation adjustment (balance sheet exposure).  

Different translation methods give rise to different concepts of balance sheet exposure and translation adjustments of differing sign and magnitude.

2. Choice of adjustment to be reported in the consolidated financial statements- The second issue relates to whether the translation adjustment should be treated as a gain or loss in income, or should be deferred as a separate component of stockholders’ equity.

Both IAS 39 and SFAS 133 provide that the gain or loss on a hedging instrument that is designated and effective as a hedge of the net investment in a foreign operation should be reported in the same manner as the translation adjustment being hedged.

The paradox in hedging balance sheet exposure is that by avoiding an unrealized translation adjustment or remeasurement gain/loss, realized foreign exchange gains and losses can arise.

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