The Art of Statutory Consolidation - Part 3

Multiple Currencies

20. 08. 18 Paul Atkinson

“All that glitters is not gold.” ~ Merchant of Venice, Morocco, Act 2 Scene 7

One of the biggest challenges as a group of companies is managing and accounting for your overseas businesses. This is no less true within the consolidation process. The challenges of dealing with multiple currencies in particular requires some unique accounting adjustments and considerations. While conceptually the issues can be complex, they all require a number of simple calculations that can be layered together and codified within a consolidation model.

What is the Currency Translation Adjustment?

One of the most common phrases encountered when dealing with currency within a statutory consolidation is the CTA - Currency Translation Adjustment (or sometimes Account, depending on who you ask). Properly, it should be called the Foreign Currency Translation Difference Upon Consolidation Reserve Account. This account represents the sum of the difference between the applied rate and the balance sheet closing rate for each individual account.

Different methods of translation

Generally accepted accounting principles (GAAP) requires us to use a number of different methods to translate our nominal accounts, based on the type of account

Average (be it weekly, monthly, YTD weighted)

Generally applied to the Income Statement/Profit & Loss, the average rate allows us to apply a rate that reflects the movement across the reporting period, rather than the point in time translation of the Statement of Financial Position/Balance Sheet. The average rate allows for this without the burden of retranslating each transaction, giving a slightly smoothed effect, by taking the average exchange rate across the time range and applying it to the relevant balance.

Closing

The simplest of all rate conversion, and used for all current/monetary items on the Statement of Financial Position, this is the current exchange rate at the date of the Balance Sheet, representing the “as at” nature of the statement.

Historic

Non-Monetary items have to be translated at a rate that reflects the time at which they were added to the balance sheet. This effectively means that a transactional spot rate needs to be applied. However, carrying the actual spot rate for each individual transaction within the consolidation process would be overly burdensome. As such, a proxy is derived known as the historic rate. This rate represents a calculated rate based on the aggregate of transactions on an account in local currency for the year against the group currency equivalent. This rate is then rolled forward into the next financial year as an opening position.

For highly stable accounts, such as share capital the closing position can be rebased each year depending upon each transaction. However certain accounts might be more volatile and as such a different approach may be required:

Asset/Non-Monetary Item Movement Basis

The Movement basis is very similar to the historic in that it tries to simplify the capturing of the carrying rate for assets (or liabilities) acquired that shouldn’t be revalued.

Movement Analysis

When looking at the movement analysis for the notes or statements that look at movements, such as the statement of change in equity, a different approach should be applied if each individual movement doesn’t have an applied rate. The opening position should be translated as the prior year closing, the movements translated at the rate applied to Income and Expenditure codes and the closing balance translated at the rate being used for that account on the primary statements. The difference between the aggregation of the movements in converted currency and the closing balance at account applied rate is then a currency difference. This difference though does not flow to the CTA.

Currency Issues Commonly Faced in Establishing a Consolidation Model

There are a number of Currency Issues that are commonly found when trying to establish a new consolidation model.

Different Group Currencies

One of the most common challenges is the desire to have a group consolidated into more than one currency or to have sub groups in different currencies to the parent groups.

The first temptation is to translate to one currency, and from there translate to another. However, this compounds the issues as the different rate types have to be triangulated between the base and first reporting currency to the second reporting currency. This is particularly difficult with historic rates as the ratio between different currencies cannot be determined just from the current exchange rates. Triangulation of these rates would require knowing the relevant exchange rate at the time of the underlying transactions.

Inter-company differences

Inter-company balances are challenging to keep in alignment at the best of times. When they’re based in different currencies the complexity increases. When the rates applied at the time of receipt of invoice differ to the time of consolidation, a difference is created between the two entities at the Balance Sheet date.

CTA

The CTA frequently seems like an account that can be used to capture most differences upon consolidation. The temptation to blame an unexplained difference to exchange differences is easy. This though creates an audit problem; how to prove the balance on this account. It should always be remembered that this account is simple by design and should always be possible to prove by taking it back to first principles; the difference between the presented balance and the balance at closing rate.

How to make things easier

There are a number of things that can be done when building a statutory consolidation model or process to de-risk and increase the efficiency of the process.

Make logically consistent decisions on fx method as part of the configuration

Eliminations reflect the reversing of balances between an entity with the corresponding equal and opposite balances with the counterparts within the same group in group currency. Ensuring that the same conversion methodology is applied to the accounts that represent both sides of the elimination makes this process simpler, such as ensuring that Investment in Subsidiaries is translated with the same methodology as Share Capital.

Rate automation

Using scripts and technology, such as R, to extract rates from sources such as Oanda through their public API allows for consistency of approach and certainty of both completeness and accuracy.

Investment Register

Use of an Asset Register and an Investment Register allows for the collection of the time of purchase/acquisition or disposal, the consideration and life of the asset/subsidiary and the rate at the time of these transactions. This allows for the controlled management of rates for non-monetary items, automation of the ownership and control percentages and therefore the consolidation method for each entity and the calculation of any depreciation or amortisation within the system.

Elimination Tolerances

Accepting that rate triangulation is not always possible, particularly with spot rates, eliminations should be configured to automatically write off differences within a tolerance. These tolerances should be either absolute or as a % of the base account balance.

Ultimately, currency translation is one of the most complex arenas within a Consolidation Platform. Lack of control or understanding in this area can lead to significant differences being posted to a reserve code that reflects currency differences, which then become very difficult to track and reconcile. Considering these factors and taking these simple steps ensures that a project to automate consolidation should go more smoothly.

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