8 Nov, 10
Posted in FAS 52 - Simplified
If an entity’s books are not maintained in its functional currency, then the financial statements are converted into the functional currency. This conversion is called “remeasurement“. If for the foreign entity the functional currency is the group’s reporting currency, then remeasurement into reporting currency cuts the step of translation.
Remeasurement process should produce the same result as if the entity’s books were being initially recorded in the functional currency. To accomplish this result -
a. It is necessary to use a historical exchange rate between functional currency and the record keeping currency for the process of remeasurement of certain accounts.
b. For all other accounts, current rate will be used.
c. The gains and losses from remeasurement of monetary assets and liabilities should be recognized in income.This is what transaction gains or losses are.
A few examples of accounts for which historical rate is to be used are – Property, Plant and Equipment and Accumulated Depreciation, Goodwill, Deferred Income, Common Stock, Depreciation, Amortization and Cost of Goods Sold.
25 Oct, 10
Posted in Other Proposed Rules
The Financial Accounting Standards Board in July proposed requiring companies to disclose to investors certain potential future losses, including those resulting from litigation. But this rule was opposed by major law firms on the grounds that such disclosure would put their corporate clients at a disadvantage in lawsuits. The law firms say that the disclosure would provide the adversaries (plaintiff’s lawyers in this case) too much information and thereby hurt their case.
The plaintiff lawyers on the other hand think the disclosures do not change any of their strategy or their road map in handling the case.
I am not a lawyer but I do believe that the disclosures of average settlement amount, litigation loss contingencies accruals and insurance coverage, would definitely make the disclosures more useful for the investors to evaluate the contingencies and its effect in the future financial statements of the company. With all the recent market upheavel, the investor community is looking for disclosures to be able to read between the lines and try and find issues that may arise in the future before it is too late!
20 Oct, 10
Posted in Other Proposed Rules
The results of a survey from the investment bank, Keefe, Bruyette & Woods and Greenwich Associates showed an overwhelming opposition of the new banking industry related fair value proposal recently released by FASB ( for the non accounting folks, FASB stands for Financial Accounting Standards Board, the accounting standard setting authority in the US). Two thirds of the investors opposed the new proposal.
One of the proposed changes would require banks to report the estimated fair value of most loans on their books alongside the current cost accounting valuations. According to the survey of 62 U.S. institutional investors, only one in five favor the proposed changes.
In August, the Mortgage Bankers Association sent a letter to FASB saying the proposals would increase the complexity in financial statements, which would make regulation more difficult. Maybe the survey results is a signal for FASB to rethink the proposal.
There is definitely need for more transperancy in bank accounting, especially after the mortgage industry crisis that we are still reeling under, but whether fair value estimation of loans is the way to go is the question. How much can one rely on the fair market values of infrequently traded loans on banks’ books!
25 Apr, 10
Posted in FAS 52 - Simplified
In order to report consolidated financial statements, companies must effectively convert multiple currencies into a single reporting currency. This leads to the company being exposed to exchange rate risks. As currencies strengthen or weaken compare to the US Dollar, the revenues and expenses of a USD reporting entity gets inflated and vice a versa.
Fluctuations in currency rates could impact the parent company’s income statement, even though the local currency results haven’t changed much. Let’s take an example; company NDS a US based company has a subsidiary in India. Considering that the functional currency of Indian sub is Indian Rupee (Rs) and the exchange rates in 2009 is Rs 50 to 1 USD and in 2010 it strengthened to Rs. 45 to 1 USD. At the end of the reporting cycle the company for the purpose of consolidation will be converting the Rs based financial statements to USD based. The revenue for the two periods is Rs. 100. In 2009, revenue on consolidated basis will be USD 2; in 2010 however the revenue will be inflated to USD 2.2. This increase is solely due to exchange rate variations and not any change in the operations of the subsidiary.
What would the impact be on the income statement will be based on the impact on the expense side. There can be a few options-
- Currency movements in revenues are naturally hedged by relatively equal movements in expenses. In this case the impact on net income will be immaterial.
- In case where the expenses are primarily incurred in the US itself and nothing in India, there will be no change in expenses, but because the revenue has increased the net income would be higher.
- If the expenses were lowered in India due to cost savings measure taken at corporate, the net income would be higher and vice a versa.
It becomes imperative for financial statement users to understand the effect of exchange rate variations on the performance of the company. Movement on the financial statements as we saw doesn’t necessarily mean there is a change in the operations of the company, it could very well be due to exchange rate fluctuations.
12 Mar, 10
Posted in FAS 52 - Simplified
The disclosures around FAS 52 or foreign currency exchange rate impact are not mandated by FASB. FASB encourages supplemental disclosures of exchange rate impacts on operating results as a means to assist financial statement users in understanding currency and comparative movements. Also isolating foreign-exchange impacts on earnings is a non-GAAP financial measure. This leads to a number of methods and techniques that have developed over the years for disclosure of exchange rate impact.
In this article I have tried to list some of the different methods companies use to disclose the exchange rate impacts on financial results.
For SEC registrants, foreign exchange impacts often are found in the MD&A and in the disclosure of market risks section of the 10-K and 10-Q.
Avon, as part of their MD&A discloses operating results that have been adjusted to exclude the impact of changes in the translation of foreign currencies into U.S. dollars. To exclude the impact of changes in the translation of foreign currencies into U.S. dollars, they calculate current year results and prior year results at a constant exchange rate. The company also discloses under risk factors key currencies that they have significant exposures in.
3M, discloses a lot of information on the sales side for foreign currency impact. The company includes in its Risk Factors, the total sales growth along with local currency sales growth. Their result of operations has a narrative on the currency effects. They also disclose in great detail the sales by segments showing the local currency sales and total sales.
Caterpillar explained year-over-year movements in its revenue and operating profit by isolating the components of such movements, including currency, in a bar chart.
American Express quantifies the percentage impact of change in exchange rate by explaining year-on-year results.
McDonald’s corporation also does a detailed disclosure related to foreign currency effect. They report constant currency results. A section is dedicated in their 10K to effects of foreign currency on operations- the key P&L lines are shown with the gain /loss due to currency in a separate column for three years. The company also reports the impact of currency on their diluted EPS. There are disclosures about the currency fluctuation on the balance sheet side as well.
There are a lot of ways of disclosing the foreign currency impact on financial statements of a company. What and how much to disclose is depends on the company and should be determined by the materiality of the impact.
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