Foreign Currency Translation - Example

Foreign Currency Translation Foreign currency translation Companies engage in expansion and international activities so as to increase its international presence. It also undertakes international activities for holding equity in the foreign companies. There are several reporting and recording problems while the transactions with the foreign firms are measured with the help of domestic currency. Hence, the transactions that are made to the foreign companies should be translated before the trade or the payment. After translation it is easy to maintain accounts and the financial statements are prepared with respect to the domestic country. This translation is mandatory so as to ensure that the transactions in the financial statements are denominated under the same unit of currency (Statement of Accounting Standards, 2015). Additionally, the payables or receivables that are denominated in the foreign currencies are porn to losses and gains because of the exchange rates changes that occurs within a shorter period of time. This phenomenon cannot be controlled as it is regulated according to the economic condition of a particular country. A company also makes commitments or prepares forecasted transactions that are subject to exchange rate changes. In such a case, loss or gain is inevitable if the changes are favorable or unfavorable. In order to avoid or reduce the risk associated with the change in exchange rate, the companies use different hedging strategies. It helps in reducing the impact of exchange rate change and thus minimizes the chances of loss (Statement of Accounting Standards, 2015). There has been huge concern related to the expansion of international business as there are several developments in the monetary system worldwide. The developments are accompanied by a number of acceptable techniques for translating foreign financial statements; as a result the company can prepare reports highlighting the losses or gains that have taken place due to the fluctuation in the foreign currency. Thus translation of the foreign currency is essential for the companies for identifying any change in the deal with foreign company (ACCA, 2015). Foreign currency translation refers to the conversion of accounting figures, stated in a particular currency into another one according to the requirements of financial requirements. It is well known that the items in the balance sheet are converted at the exchange rate based on the balance sheet date; moreover, the same conversion also takes place in case of income statement items. These values are converted with respect to the weighted –average exchange rate for the particular year. The losses and gain, which results from the conversion are depicted in equity section of the balance sheet. The changes that occur in the exchange rate between the audit report date and financial statement date is disclosed in the following financial statements of the company (ACCA, 2015). The foreign currency translation in Qatar is very interesting as during 1970’s as Qatar did not have its national currency since it was influenced by the British administration (Al-Thani, 2011). They relied on the foreign banks. However, the establishment of the first domestic bank i.e. Qatar National Bank during 1965 changed the situation to a great extent. During March 1966, an agreement related to currency was signed between Dubai and Qatar. At this time, Qatar-Dubai riyal was established and it replaced the foreign currencies (Al-Thani, 2011). The conversion made it easy for Qatar to determine its revenue at the end of each financial year in its own currency. Until 1980 the riyal was fixed at 3.64 of the US dollar; however, it changed in the past two decades drastically. Presently, $1 is equal to 3.63 Qatari riyal. This helped the companies in Qatar to establish an uninterrupted business and minimize the loss that was occurring due to the difference in currency. Qatari is engaged in several international activities and thus it is helpful for them to convert the transaction amount in the local currency so as to avoid loss (Al-Thani, 2011; Delliotte, 2015). During March 1975, the riyal peg was converted from the US dollar to the special drawing right (SDR). The exchange rate was 1 SDR is equal to 4.7619 riyal, where the marginal variations were observed to be ±2.25% (Al-Thani, 2011). Therefore, the exchange rate related to Qatari riyal was fixed according the exchange rate of other currencies (Al-Thani, 2011). The fluctuations in the riyal exchange rate are depicted in the following graph: Figure 1: Fluctuations in QR during the period 1973-2000 (Source: Al-Thani, 2011) From the above graph it can be stated that the SDR depreciated to a great extent after the fourth quarter of 1975 and the marginal variation was observed to be ±7.25%. Hence, the monetary agency examined that the daily value of Qatari riyal against the US as the intervention currency. Ay 1980, the exchange rate for Qatari riyal was 3.64 against 1 dollar US dollar. Importance of translation A particular entity execute foreign activities in two ways; either it might undertake transactions in foreign currency or is eager to undertake any foreign operations. Moreover, the entity prepares the financial statements in the foreign currency also. The main issue regarding the preparation of the financial statement is to understand which exchange rate is to be used and how the effect of changes is noted. The International Financial Reporting Standards (IFRS) prescribes the steps that are to be followed for including foreign operations and foreign currency transactions in financial statements of the entity. It also depicts the process for translating the financial statements into the desired currency. The standard does not use hedging for safeguarding the items in the foreign currency. The translation is needed for assuring the company whether there is any loss or gain in the trade. The functional currency is determined at the initial stage of translation process. The functional currency refers to the currency that is used in the primary economic environment, where the entity is operating (ACCA, 2015). Foreign currency translation is employed for converting the outcome of the subsidiaries of parent companies into its reporting currency. The translation plays a pivotal role in the consolidation process of the financial statement (Arab News, 2015). The steps required in this translation process are discussed henceforth. In the first step, the functional currency of the foreign company is determined. Secondly, the financial statement of the foreign company is re-measured into the currency of parent company. In the third step, the gains and losses that occur during the translation process are determined and recorded for adjusting it in the next years’ financial statement (Arab News, 2015). The transaction involving foreign currency should be registered as per the exchange rate that is available in the transaction date. Hence, the balance sheet depicts those amounts at the rate of closing and the difference between the exchange rate at the time of translation and preparation of the financial statements are adjusted at different rates (Ernst and Young, 2014). In Qatar, the importance of foreign currency translation can be observed from Figure 1, which depicts the overall fluctuation in the exchange rate during the period 1973 to 2000. It is essential for the Qatari companies with other countries as for example the US. For the sake of foreign currency translation, the companies in Qatar change the amount in US dollar in to the domestic currency based on the present exchange rate (Al-Hamidy & Banafe, 2007). However, the difference in this conversion process in depicted henceforth. If a company translates a particular amount in foreign currency into US dollar equivalent figures by employing historical exchange rate, the alterations in the exchange rates had no effect in the valuation of the US dollar. This is because the figure appears in the US dollars at the acquisition rate, which was set at the date of acquisition (Krueger, Kamar & Etienne, 2009; Treasury of Qatar, 2014; Watkins, 2013). Moreover, the importance of foreign currency translation can also be explained by highlighting the factors affecting the exchange rate of two countries. Here, the two countries considered for the explanation are Qatar and the US (Krueger, Kamar & Etienne, 2009). The factors are evaluated in order to understand the volatility in exchange rates. The volatility in exchange rate is dependent on a number of economic factors, which have different degrees of importance around the globe. The exceptional and special factors affecting the exchange rates are also common in other countries such as the UK, US etc. This has huge impact on the conversion of foreign exchange rates, which in turn influence the elements in balance sheet and income statement of different companies operating in different countries (Krueger, Kamar & Etienne, 2009). The factors are discussed henceforth. 1) The foreign exchange rate is influenced by the flow of export and import that takes place between different countries. 2) The flow of capital in certain country can also influence its exchange rate. 3) Inflation has the capacity to affect exchange rates in a country. 4) The government of a country also plays an important role in ascertaining the exchange rate. Hence, it can be stated that the fluctuations in the exchange rates are regulated by the government; hence their role has a huge impact on determination of the exchange rate of the country (Krueger, Kamar & Etienne, 2009). 5) The short and long term interest rate differential has the ability to influence the exchange rate of different countries. 6) The cost of borrowing of a particular company has the capacity to effect the exchange rate fluctuation in the long run. Therefore, the above mentioned factors are capable of affecting the exchange rate of the countries, which in turn influence the conversion based on the present exchange rate. The following section highlights the affect of these factors on the exchange rate of the selected countries (Krueger, Kamar & Etienne, 2009). Qatar employs riyal as the official currency; thus it is known as Qatari riyal. The currency code for Qatari Riyal (QR); the country had adopted the currency during 1973 (CRNIndia, 2015). Since, then the company has encountered fluctuations in the value of the exchange rate. This is because of the different economic factors. The government in Qatar is responsible for regulating the exchange rate. The Gulf Cooperation Council (GCC) includes six Arabian counties such as Bahrain, Kuwait, Qatar, United Arab Emirates, Saudi Arab and Oman (Krueger, Kamar & Etienne, 2009). The country had developed intra-union trade in the past so as to enhance the relationship with countries around the globe (Krueger, Kamar & Etienne, 2009). During 2002, the states of GCC regions decided to peg each of their currencies to US dollars, which was an important step for developing a new and common currency. The chosen dollar peg highlighted increased earnings in dollars. The reason behind this increase was export of natural gas and oil (Al-Hamidy & Banafe, 2007). The dollar peg ascertains the external value of currencies with respect to dollar. In this manner, the bilateral exchange rates are also established between the member countries. The reliance on dollar value and the external peg depicts the fact that the region imported the monetary policy of the US. The increase in price in Qatar with respect to fixed and nominal exchange rates had appreciated the real exchange rate with respect to GCC countries during 2007-2008 (Krueger, Kamar & Etienne, 2009; Reuter, 2012). Reasons for translation Foreign currency translation is needed for assuring whether a trade is bringing any negative effect on the companies, who are involved in the same. The translation process is necessary for assuring that there is no loss for domestic and foreign country. Foreign currency translation is prominent in international trade or expansion. When a company trades with another foreign country, both of them are subject to change in exchange rates over the period of time. The accounts receivable for the foreign country is determined based on the exchange rate that is prevalent in that country; however, the accounts payable of the domestic country is based on the domestic exchange rate. Hence, there is a possibility that the gap between the receipt and payable value is different. The reason for foreign currency translation is discussed henceforth (Ernst and Young, 2014). Translation helps in facilitating preparation of consolidated financial statements, which gives permission to the readers to examine and evaluate the performance of multinational companies. It also helps in facilitating measurement of the exposure of the company to the risk in foreign exchange. The government of United States and Qatar had concluded on the agreement for improving the international tax compliance. United States had enacted on the provisions that was commonly known as Foreign Accounts Tax Compliance Act (FATCA) that introduced rules for reporting that are adopted by financial companies related to representation of accounts. The Qatar government was also supportive about the goal of underlying policy of FATCA, which aimed at improving the tax compliance. Through this act a number of rules were also developed for the currency translation (Treasury of Qatar, 2014). This implies that the translation is needed for enjoying better tax adjustments. The tax adjustments also help the company to reduce the financial burden and prepare an adjusted financial report that highlights the translated figures appropriately. Hence, it can be stated that the agreement between the US and Qatar had given opportunity to the companies to present a currency and tax adjusted financial reports. This helps them to avoid any loss owing to the fluctuations in exchange rate (Treasury of Qatar, 2014). Translation method The methods of foreign currency translation are discussed henceforth. Single rate and multiple rate methods are explained in the first place. The single rate translation method employs a single exchange rate and current rate to all the foreign liabilities and assets (Cengage Learning, n.d.). However, the multiple rate method applies foe combinations of exchange rate and historical rate for converting the foreign currency balances. Secondly, the non-current and current methods have huge impact on the financial reporting of the companies. The current liabilities and assets are converted at current rate; however non-current liabilities and assets are converted at historical rates. The expenses and revenues are converted at the average rates whereas amortization and depreciation charges are imposed based on the historical rates. The following table highlights the methods that are used for computing the different elements in a balance sheet of a company (Cengage Learning, n.d.). Apart from the above mentioned methods, monetary and non-monetary methods are also important. The monetary assets are converted at the current rates; however, the nonmonetary ones are translated at the historical rates. This is quite similar to current and non-current methods of translation (Cengage Learning, n.d.). Translation accounting development from 1965 to 1981 Before 1965, the US companies followed the Accounting Research Bulletin for formulating translation practices. It advocated the current-non-current method of translation. The loss or gain related to the transactions is taken directly to the income. During the period 1965-1975, the Accounting Research bulletin included certain exceptions to current-non-current methods (Choi & Meek, 2007). The inventory is translated at the historical rates. Curing 1975-1981, a variety of treatments were permitted for setting the translation standards. Since 1981 to present several pronouncements were made. For responding to the dissatisfaction, the FASB reconsidered the public meetings and two exposure drafts (Choi & Meek, 2007). References ACCA. (2015). IAS 21 The Effects Of Changes In Foreign Exchange Rates. [online] Available at: [Accessed 28 May 2015]. Al-Hamidy, A. & Banafe, A. (2007). Foreign Exchange Intervention In Saudi Arabia. [online] Available at: < http://www.bis.org/publ/bppdf/bispap73v.pdf > [Accessed 27 May 2015]. Al-Thani, F. (2011). Monetary Policy In Qatar And Qatar’s Attitude Towards The Proposed Single Currency For The Gulf Cooperation Council. [online] Available at: < http://www.bis.org/publ/bppdf/bispap17j.pdf > [Accessed 27 May 2015]. Arab News. (2015). Inflation Spikes As Qatar Gears Up For Spending Spree. [online] Available at: < http://www.arabnews.com/news/450145 > [Accessed 27 May 2015]. Cengage Learning. (no date). Foreign Currency Translation. [online] Available at: < http://www.cengage.com/resource_uploads/downloads/0324381980_74247.pdf > [Accessed 27 May 2015]. Choi, D. & Meek, G. (2007). International accounting. New Delhi: Pearson Education India. CRNIndia. (2015). Saudi Riyal. [online] Available at: [Accessed 27 May 2015]. Delliotte. (2015). Qatar International Islamic Bank (Q.S.C.) Doha – Qatar. [online] Available at: < http://www.qiib.com.qa/qiib/resources/pdf/29_en.pdf > [Accessed 27 May 2015]. Ernst and Young. (2014). Foreign Currency Matters. [online] Available at: [Accessed 28 May 2015]. Krueger, R., Kamar, B. & Etienne, J. (2009). Establishing Conversion Values for New Currency Unions: Method and Application to the planned Gulf Cooperation Council (GCC) Currency Union. [online] Available at: < http://www.imf.org/external/pubs/ft/wp/2009/wp09184.pdf > [Accessed 27 May 2015]. Reuter. (2012). Qatar Raises GDP Growth And Inflation Outlook. [online] Available at: [Accessed 27 May 2015]. Statement of Accounting Standards. (2015). Foreign Currency Translation. [online] Available at: < http://www.aasb.gov.au/admin/file/content102/c3/AAS20A_12-87.pdf > [Accessed 28 May 2015]. Treasury of Qatar. (2014). Agreement between the Government of the United States of America and the Government of the State of Qatar to Improve International Tax Compliance and to Implement FATCA. [online] Available at: [Accessed 27 May 2015]. Watkins, S. (2013). What Would It Mean If Qatar Dropped The Dollar Peg? [online] Available at: < http://www.theedge.me/what-would-it-mean-if-qatar-dropped-the-dollar-peg/ > [Accessed 27 May 2015]. 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