How do I record the translation adjustment when consolidating a foreign subsidiary after translating their FS into the reporting currency?
Stephen Helfrich (CFO/Consultant, In Transition/Consulting/Interim CFO)
| Sep 28, 2011I recently started working for a company that has a Mexican Mequilladora operation and they have not been correctly implementing FAS 52 as it applies to financial statement translation, so when I translated the Mexican operation's financial statements from Pesos to Dollars and went to record the translation loss to equity, I realized I had a one-sided adjustment that was needed in order to bring the Mexican dollar statements back into balance, which I guess means that the adjustment must only be an adjustment for reporting purposes and that it doesn't get recorded in the accounts; or am I doing something wrong?
Answers
Company: Consultant
Hi Stephen,
The cumulative translation adjustment(CTA) arises as the all of the monetary assets (cash, financial assets, etc.) are translated at the current rate, but the non-monetary assets are translated at the historical rate. The CTA account captures the difference between these two exchange rates in US$. Hence, the CTA amount is the balancing amount so you can consolidate and report the Mexican operations in US$.
So what happens to the accumulated CTA balance? The CTA balance accumulated over the years is recorded in the Accumulated Other Comprehensive Income (AOCI), which is a component of equity.
Stephen.....let me know if the above helps. If not please feel free to contact me and I can walk you with a working example that is more specific to your situation as I have worked with a lot of complex foreign exchange related issues.
Please note that you might need to also need to consider some other accounting issues, such as is the net investment in the Mexican operations hedged? If yes, was it hedged using a derivative or non-derivative. Also CTA is only released through the income statement under very specific situations.
Best regards,
theIFRS [dot] com
Sunil
Email: Sunil
Company: In Transition/Consulting/Interim CFO
Sunil:
Thank you for answering my question and for making the offer to contact you with additional questions, I appreciate the assistance. What really has me curious is that as you state "the CTA amount is the balancing amount so you can consolidate and report the Mexican operations in US$" but as I think through the statement translation process the CTA by definition seems to be a one-sided balancing amount and therefore by deduction I think only an amount used for reporting purposes "a balancing amount to make the consolidation process work" and therefore it doesn't get recorded in any GL accounts. Is this thinking correct?
Company: Consultant
Hi Stephen - This is the same email I had sent you last night - posting it here as it might be helpful for the others in the group.
The CTA is recorded in consolidated financial statements. It is not a single entry.
The double entry is will be as follows:
Assume you invested an amount of US$100 million in the foreign (Mexican) operation - a separate legal entity. Further assume that your US$ investment has appreciated to US$120 million, only due to the change in the foreign exchange rate. So how do you record the US$20M unrealized gain in your books.
DEBIT: Increase in foreign assets (investment) US$20M
CREDIT: Cumulative Translation Adjustment account (CTA) US$20M
You will record the following journal entry when you liquidate your foreign subsidiary (certain conditions apply - refer to guidance in FIN 37):
DEBIT: Cumulative Translation Adjustment account (CTA) US$20M
CREDIT: Income Statement US$20M
The above is a simple example - but possibly acts more clarity for you.
It is better to work with a practical example. The above is a very simple example, but in real accounting world you might have more follow-up questions.
Please feel free to connect with me if you have any additional questions.
Cheers,
Sunil
P.S.: The foreign exchange guidance is now contained in ASC 830, Foreign Currency Matters (formerly FAS 52 and FIN 37).
Company: SAP
Another reason for CTA balance is typically Income statement accounts, because transactions happen through out the month are converted at the average currency exchange rate for the month while balance sheet accounts are "as of"/balance accounts and currency is calculated at the month end rate. This creates an out of balance situation in the balance sheet similar to what Sunil outlines because two different rates are used. We see about 95% of our customers using average rate for income statement accounts and end of month currency rates for balance sheet about 5% use the same rate for both balance sheet and income statement accounts.
When I used to be responsible for world wide financial consolidations I used to also reconcile the CTA account every month by applying a YTD average rate to the income statement and take the difference to the income statement at the MTD average rate and get it to equal CTA. When I worked on European financial consolidations we did this at the account level and even stored the difference so we had a virtual reconciliation. The point is there is a way to reconcile what is in the CTA account. I will try to dig out (or create) an excel file that shows the reconciliation.
Company: Consultant
Hi Ric,
You are correct in stating that the CTA is also created due to the difference in the foreign exchange rates for recording the P/L items and the closing rate (that is the period end rate/ balance sheet rate). The more complex the organization, the more assumptions are made as to what should be the average rate to be used to record these transactions.
For the P/L transactions, companies might either use start of the month rate or the month-end rate.
U.S. GAAP allows you to use the average rate of the month, however, what if there is a material transaction during the month that will skew the foreign exchange rate. So I know companies have a policy to exclude these material transactions in the determination of their average rates. These material transactions are recorded at their actual rate as of the date of the transaction.
By the way, the CTA number can be mathetically be verified and it is NOT A PLUG number, but anyone who has actually tried to verify the CTA number will agree with me that it is a very cumbersome exercise. I look forward to hearing from your experiences on how your companies make assumptions on the average rates and if you ever reconcile the CTA number for reasonableness.