Translating Current Assets in Forex
A rule followed by many companies is to translate current assets and liabilities at the rate of exchange that obtains on the date on which valuation is being made. Capital assets and other long-term assets/liabilities are translated at the rate in existence when they were acquired or incurred.
Two authoritative publications that outline translation methods in detail are "Accounting Research Bulletin 43" of the American Institute of Certified Public Accountants, Chapter 12, "Foreign Operations and Foreign Exchange," and "Research Report 36" of the National Association of Accountants, Management Accounting Problems in Foreign Operations.
In theory, cash on hand could be converted into another currency at the current rate. Other current assets are equivalent to, or realizable in cash, and therefore, follow the same rule. Since cash is used to pay current liabilities, they also follow the rule.
Inventory may follow special rules, when it is possible, to adjust the price readily, since the realizable foreign currency equivalent may then be higher than the book value. Current assets and current liabilities stated in other currencies must be separately evaluated.
The rationale for keeping capital assets at a constant value has already been set forth. Long-term debt is generally considered to be used to acquire capital assets. It is, therefore, appropriate to take into account changes in the value of long-term debt, only as they are realized by paying off the debt.
For the purpose of translating long-term debt, it makes no difference in what currency the debt is denominated until all or any part of the debt becomes short, if the rule is to keep the debt at a constant currency equivalent. To illustrate, a British company affiliated with a U.S. company borrows DM 1,000,000 in 1966, payable in 1973.
In 1966 the sterling equivalent is £88,130, and the dollar equivalent is $250,000. In translating the accounts into dollars, $250,000 is used as the value. In 1967 the pound is devalued to $2.40. No adjustment to the dollar equivalent is made, although £104,170 will be required when payment is due.
In 1969 the mark is revalued upward. Now the dollar equivalent of DM 1,000,000 is $273,000 and the pound equivalent is £113,750, but again, no change is made in the dollar equivalent. In 1972 the debt becomes short.
At that time a loss of $23,000 will be picked up, in the translation into dollars, of the accounts, and a sterling loss of £25,620 will be picked up by the British company in its accounts, adjusted by changes in the values of the two currencies since 1969. The actual bookkeeping of the British company will be governed by U.K. tax and legal considerations, so that the sterling loss may have been reflected earlier. That, however, will have been adjusted in translating the accounts, so that the effect is as given here.
The procedure described roughly brings in the gain as the capital assets are used up, and to some extent it offsets the economic loss referred to, if price adjustments lag, or are not made. Other long-term assets and liabilities are generally handled in the same way.