In today’s global economy, many companies conduct business in currencies other than the currency in which they report. Goods are often imported or exported with prices stated in a foreign currency. For the purpose of reporting, foreign currency balances must be stated in the company’s reporting currency. That is done by multiplying the foreign currency by an exchange rate.
To restate foreign currency balances, accountants consider two questions:
What is the appropriate exchange rate for converting foreign currency balances?
How does one account for changes in the exchange rate?
Companies often engage in foreign currency hedging activities in order to avoid any adverse impacts of exchange rate changes. As a result, accountants must determine how to account for these hedging activities.
Many U.S. companies have significant financial interests in foreign countries. As a result, the way in which foreign currency is translated into U.S. dollars is significant. The two major issues related to the translation process are:
Which translation method to use.
Where to report the resulting translation adjustment in the consolidated financial statements.
Translation methods differ based on whether accounts are translated at the current exchange rate or at historical rates. Accounts that are translated at the current exchange rate are exposed to translation adjustment. Different translation methods result in different concepts of balance sheet exposure.