Currency instability exposes accounting policy weaknesses

Economic volatility in Greece, Russia, Venezuela, Brazil, and other major countries has decreased demand for many local currencies and increased the demand for U.S. dollars. This has resulted in a devaluation of most major currencies over the last 12 months: 8 percent for the British pound, 19 percent for the Canadian dollar, 21 percent for the Mexican peso and Japanese yen, 23 percent for the euro, and 26 percent for the Australian dollar.

For companies using the U.S. dollar in their financial reporting, currency devaluations are causing fluctuations in the value of certain assets and liabilities that are far beyond what financial managers and statement users are accustomed to. For some, these devaluations have exposed weaknesses in their accounting policies, which are likely to cause misstatements in times of instability.

Following are some tips to help companies avoid missteps:

• Avoid translating year-to-date financial results of foreign subsidiaries using year-to-date average exchange rates. If the year-to-date exchange rate continues to fall, this method could result in January results being deflated each time they’re reported. Instead, companies should consider locking in prior-month results using prior-month average rates and stacking the translated results.
• Formally determine the settlement currency of intercompany balances and adjust one entity’s results for the foreign currency exchange gain or loss. Given the informal nature of many intercompany balances, the settlement currency isn’t always clear. Without deciphering these facts, one entity’s books will be misstated.
• While the foreign exchange impact of intercompany balances is typically included in net income, there are circumstances where it may be more appropriate to include the changes directly in equity as a part of the foreign currency translation adjustment. Now may be the time to determine which policy is appropriate in each circumstance.
• Purchase accounting adjustments, which are maintained in consolidation only and haven’t been pushed down to the subsidiaries’ books, are typically maintained in the reporting currency. Financial managers and financial statement users should be aware that if these adjustments pertain to an entity that uses a foreign currency as its functional currency, consolidating adjustments must also be assessed for foreign currency fluctuations, regardless of which currency they’re being maintained in for reporting purposes.

These are just a few of the more common considerations that are coming to light with the increased volatility in foreign exchange rates. With almost half of the year still remaining until annual reporting must be prepared, there’s still time to plan ahead to mitigate some of these issues.