What is a Foreign Currency Translation?

Foreign currency translation, in its simplest sense, is any calculation that involves expressing a monetary amount in one currency in the units of a different currency. Determining how many Japanese Yen (JPY) $100 U.S. Dollars (USD) will buy is an example of a straightforward foreign currency translation. In business, however, currency translations are often much more complicated. When corporations do business across borders, or purchase assets or supplies abroad, they must often engage in special foreign currency translation accounting practices. Translations must usually be made in several steps according to certain guidelines and national laws.

Currency translation is an important part of the global commerce landscape. How money from one country is valued in another informs many different business decisions, from the timing of imports and exports to the locations of overseas offices. Exchange rates fluctuate constantly. Daily changes are usually minimal, but depending on how much money is at stake, even the smallest change can have a significant impact on a company’s bottom line. Accurate and uniform foreign currency translation practices are accordingly very important.

Most national governments — and some local governments, as well — require companies within their borders to make routine disclosures and public statements valuing their assets. Reporting rules usually apply to any company with a presence, no matter where the company is headquartered. Companies that transact a lot of business abroad, as well as companies that are owned by foreign entities, must usually engage in quite a lot of foreign currency translation in order to submit financial statements that reflect all earnings and losses in but a single currency.

Businesses must almost always report foreign financial transactions in the local currency. This usually involves translation of foreign financial statements and foreign currency accounts as well as translation of overall corporate value. Disclosures must usually be made in the form of a consolidated financial statement, which is a single statement that lists all of the company’s transactions.

Foreign currency translations in the corporate context typically involve the identification of three distinct currencies. Accountants performing currency translations usually start by isolating the “currency of the books and records,” which is the currency that the parent company uses to conduct its everyday business. The second relevant currency is the “functional currency,” which is the primary currency of the foreign transactions. Finally, the “reporting currency” is the currency that must be used in the consolidated financial statement. The reporting currency is often the same as either the currency of the books and records or the functional currency, but not always.

The specific rules governing how foreign currency translation must be conducted are usually a matter of national law. Laws usually stipulate the calendar date that companies must use to determine the relevant exchange rate, for instance, and set out specific rules to be followed in compiling consolidated financial statements. Rules for reporting currency fluctuations and deviations are also frequently included.