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Foreign currency translation in ERP software transactions

Given that GAAP states that you use the rate as of the effective transaction date, the rate to use when receiving product on an inbound purchase order from a supplier that bills you in a different currency would seem obvious - namely, the rate as of that date (or week or month if you're using average rates, or a hedged rate if applicable). However, I get numerous objections to this from business owners (mostly smaller businesses) - they want to use the rate at which they actually pay the supplier, even if their terms are something like 90 or 120 days and they don't hedge. Which is not only contrary to GAAP, but also untimely - you already sold the products and reported on gross margins, etc., and now 3 months later you want to revalue the items based on your decision to gamble with exchange rates? Has anyone come up with a good, simple way toe explain this to a small business owner who does not understand accounting?

Answers

Topic Expert
Sunil Thukral
Title: Controller/Technical Accounting Advisory..
Company: Consultant
(Controller/Technical Accounting Advisory/ SEC Reporting, Consultant) |

Mark,

The best way to explain is by asking the question - Do you want the financial statements under U.S. GAAP basis or on cash basis?

Also by not recording the transaction in the month it is received - how do you plan to close the books on time?
By the way how are you recording the FX difference between the transaction date rate and the settlement date rate? It will also impact your P/L?

Sunil

Len Green
Title: Performance Improvement Consultant and E..
Company: Haygarth Consulting LLC
LinkedIn Profile
(Performance Improvement Consultant and ERP Strategist, Haygarth Consulting LLC) |

Mark
For many small business owners, there is a GAP in their understanding of GAAP rules on FX:).

I'd steer away from trying to explain theory to them and look at:
1. are the currencies they are dealing in subject to anything more than minor fluctuations? If not, tell them not to sweat the small stuff. If fluctuations are major, they maybe should be hedging anyway.
2. using the FX gain/loss as a metric to indicate how wildly their foreign currencies vary from purchase (or PO) time to settlement time. If a currency consistently appreciates against the USD, maybe the FX loss metric is an indicator to either raise sales prices or seek better supplier terms. So, the FX gain/loss tells the owner very clearly how smart or dumb s/he is in setting prices and achieving desired margins, especially if they give discounts in an ad hoc manner).
3. You as the trusted finance advisor can use the gain/loss trends to advise them on how to set pricing.

Topic Expert
Bob Scarborough
Title: CEO
Company: Tensoft, Inc.
(CEO, Tensoft, Inc.) |

Well said. I'm thinking many companies use estimated rates or average rates instead of transaction specific rates (for non balance sheet transactions) as well ... another simplifying assumption.

Topic Expert
Keith Bergman
Title: Managing Director
Company: Ledgewood Advisory Group
(Managing Director, Ledgewood Advisory Group) |

Mark,

I think the best approach is to establish a policy for all foreign currency transactions. I recommend you record and convert the transactions to local currency using a month end published spot rate. This is simple and is 100% GAAP compliant. I do caution you that there will be FX risk, but unless your FX volume is large I would be concerned at this time. There are ways to mitigate FX risk which can be discussed.

Regards,
Keith

Mark Canes
Title: President
Company: Blue Link Associates Limited
(President, Blue Link Associates Limited) |

Agreed - that's in line with what I recommend. The pushback I get relates to the timing as opposed to the rate. I think Len Green's suggestion of avoiding any theory, and using the gain / loss trends may fly.

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