Question

What are the current practices and procedures for translation of financial statements in the United Kingdom? Visit the Institute of Chartered Accountants in England and Wales’ website to start your research.

Answer 1

Current practices and procedures for translation of financial statements in the United Kingdom

Financial statement translation is a corporate accounting process by which a parent company converts a foreign entity’s financial statements into its reporting currency to prepare consolidated financial statements.

Accounting standards require that multinational companies’ financial reports include the results of their foreign entities. Thus, in every reporting period, the parent company must translate its foreign entities’ financial statements into its reporting currency.

This translation can be done through three methods:

• Using the market rate on the reporting date;
• Using a weighted average exchange rate;
• Using historical exchange rates (only in the case of non-monetary assets and liabilities).

When the foreign entity’s financial standards have been translated, the parent company must include these amounts in its consolidated income statements.

Consequently, these companies’ statements may be sensitive to adverse movements of the exchange rates, depending on their volume of assets and liabilities denominated in foreign currencies. This is known as translation risk.

An entity may carry on foreign activities in two ways. It may have transactions in foreign currencies or it may have foreign operations. IAS 21 prescribes how an entity should:

• account for foreign currency transactions;
• translate financial statements of a foreign operation into the entity’s functional currency; and
• translate the entity’s financial statements into a presentation currency, if different from the entity’s functional currency. IAS 21 permits an entity to present its financial statements in any currency (or currencies).

The principal issues are which exchange rate(s) to use and how to report the effects of changes in exchange rates in the financial statements.

An entity’s functional currency is the currency of the primary economic environment in which the entity operates (ie the environment in which it primarily generates and expends cash). Any other currency is a foreign currency.

The following procedures apply when an entity accounts for transactions in a foreign currency. A foreign currency transaction is recorded, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate at the date of the transaction. At the end of each reporting period:

• foreign currency monetary items are translated into the functional currency using the closing rate;
• non-monetary items that are measured in terms of historical cost in a foreign currency continue to be translated using the exchange rate that prevailed at the date of the transaction; and
• non-monetary items that are measured at fair value in a foreign currency are translated using the exchange rates that prevailed at the date when the fair value was measured.

The resulting exchange differences are recognised in profit or loss when they arise except for some exchange differences that form part of a reporting entity’s net investment in a foreign operation. The latter are recognised initially in other comprehensive income and reclassified to profit or loss on disposal of the net investment.

For translation into the functional currency or into a presentation currency, the following procedures apply, except in limited circumstances:

• assets and liabilities are translated at the exchange rate at the end of the period;
• income and expenses are translated at exchange rates at the dates of the transactions; and
• resulting exchange differences are recognised in other comprehensive income and reclassified to profit or loss on disposal of the related foreign operation.