What Is Currency Translation?

Currency translation is the process of converting one currency to another within a company's financial reporting. Currency translation for a business is usually done in the context of a parent company with subsidiaries. The parent company has a functional currency, which is the currency of the primary economic environment in൩ which that company generates and expends cash flows.

For transparency purposes, companies with overseas ventures may be required to report their accounting figures in one currency. If the subsidiaries of the 澳洲幸运5官方开奖结果体彩网:parent company operate in a different country and use a different currency, the financial results of those foreign subsidiaries are translated into the functional currency of the parent company using currency translation.

How Currency Translation Works

Many companies, particularly big ones, are multinational, operating in various regions of the world that use different 澳洲幸运5官方开奖结果体彩网:currencies. If a company sells into a foreign market and then sends payments back home, earnings must be reported in the currency of the place where the majority of cash is primarily earned and spent. Alternatively, in the case that a company has a foreign 澳洲幸运5官方开奖结果体彩网:subsidiary that does not transfer funds back to the parent company, the functional currency for that subsidiary would be the local currency where it operates.

Before a foreign entity's financial statements can be translated into the reporting currency, the foreign unit's financial statements must be prepared according to 澳洲幸运5官方开奖结果体彩网:General Accepted Accounting ᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚPrin🐟ciples (GAAP). After the financial statements are prepared, they are translated into the functional currency using different 澳洲幸运5官方开奖结果体彩网:exchange rates.

• 澳洲幸运5官方开奖结果体彩网:Assets and liabilities use the exchange rate between the functional currency and reporting currency at the end of the period.
• 澳洲幸运5官方开奖结果体彩网:Income statements use the exchange rate on the date that income or an expense was recognized; a weighted average rate during the period is acceptable.
• 澳洲幸运5官方开奖结果体彩网:Shareholder equity, which is mostly made up of common stock and dividends, uses the historical exchange rate at the date of entry to shareholder equity.

Gains and losses resulting from currency conversions are included in net income and recorded in financial statements. The change in foreign currency translation is a component of 澳洲幸运5官方开奖结果体彩ඣ网:accumulated other comprehensive income. This is presented in a company's consolidated statements of shareholders' equity and carried over to the consolidated 澳洲幸运5官方开奖结果体彩网:balance sheet under shareholders' equity.

If a company has operations abroad that keep books in a foreign currency, it will disclose its currency translation methodology in its 澳洲幸运5官方开奖结果体彩网:footnotes as "Summary of Significant Accounting Policies" or something substantially similar.

Constant Currency

Constant currency is another term that often crops up in financial statements. Companies with overseas operations often choose to publish reported numbers alongside figures that strip out the effects of exchange rate fluctuations. For example, in the fiscal quarter ending Nov. 30, 2020, Nike Inc. reported a 9% increase in revenues, adding that sales rose 7% on a constant currency basis.

Investors generally pay a lot of attention to constant currency figures as they recognize th𓄧at currency movements caꦓn mask the true financial performance of a company.

Currency Translation Accounting Methods

Ther🐈e are two main accounting standards for handling currency translation.

Current Rate Method

The 澳洲幸运5官方开奖结果体彩网:current rate method is used when the subsidiary isn't well integrated with the parent company, and the local currency where the subsidiary operates is the same as its functional currency. Using thꦿis method, most 👍items in the financial statements are translated at the current exchange rate.

The Temporal Method

Also known as the historical method, the 澳洲幸运5官方开奖结果体彩网:temporal method converts the currency of a foreign subsidiary into the currency of the parent company. The temporal method is used when the local currency of the subsidiary is not the sam✱e as the currency of the parent company. Differing exchange rates are used depending on the fiꦆnancial statement item being translated.

Translation Risk

澳洲幸运5官方开奖结果体彩网:Translation risk is the exchange rate risk associated w🅷ith companies that deal in foreign currencies and list foreign as🦹sets on their balance sheets.

Companies that own assets in foreign countries, such as plants and equipment, must 澳洲幸运5官方开奖结果体彩网:convert the value of those assets from the foreign currency to the home country's currency for accounting purposes. In the U.S., this ac🧜counting translation is typically done on a quarterly and annual basis. Translation risk results from how much the assets' value fluctuate based on exchange rate movements between the two counties involved.

For example, when the U.S. dollar strengthens against other currencies, it subsequently weighs on international financial figures once they🗹 are converted into U.S. dollars.

Multinational corporations with international offices have the greatest exposure to translation risk. However, even companies that don't have offices overseas but sell products internationally are exposed to translation risk. If a company earns revenue in a foreign country, it must convert that revenue into its home or local curr꧑ency when it ൩reports its financials at the end of the quarter. 

Hedging Currency Translation Risk

Companies seek to overcome adverse fluctuations in foreign exchange rates by hedging their exposure to currencies. Many companies will acquire 澳洲幸运5官方开奖结果体彩网:foreign ex🧔change (forex) derivatives, such as 澳洲幸运5官方开奖结果体彩网:futures contracts and options, to lock in a currency rate and ensure that it remains the same over a specified period of time. This minimizes the impact of currency translation risk on their reported assets.

The Bottom Line

When a parent company has foreign subsidiaries or operations, it must reconcile any income statements in foreign currencies to its local currency. This is done using a process called 🍷currency translation.

Different exchange rates are used for this process, depending on which financial reports are beꦏing translated. Assets and liabilities are translated using the exchange rate at the end of the reported 🐼period. The income statement is translated using the exchange rate on the date that income or expense was recognized, while shareholder equity is reconciled using the historical exchange rate at the date of entry.

Because of the fluctuations in these exchange rates, currency translation poses some financial risk for the parent company. If the exchange rates fluctuate before the financial statements have been reconciled, the parent company faces potential losses on its own income statements. This risk can be hedged with currency derivatives or forex positions.