Consolidating journal entries
Although the rules on accounting for foreign-currency translations have not changed in many years, mistakes in this area persist. With the increase in foreign transactions comes a parallel increase in foreign-currency reporting, and since many companies do business in multiple countries, the complexity of such reporting is on the rise.Such mistakes can result in misstatements in financial reporting, hurting the bottom line, creating false understandings of business results, and exposing companies to possible regulatory scrutiny. exports are growing at a healthy pace, as a slumping dollar makes goods from the U. The risk of accounting errors in foreign-currency transactions has been compounded by significant volatility in the value of the U. dollar compared with some other currencies, especially in the past 18 months. companies expand their presence in global markets, it is more important than ever to understand and address the most common pitfalls associated with working with foreign currencies.A key factor raising the stakes in foreign-currency reporting is the fact that U. companies are increasingly looking offshore for growth. And this volatility will likely continue, given recent headlines, such as the spike in the yen’s value following Japan’s devastating earthquake last March, the rise of China’s yuan to a new high versus the U. dollar last summer, and runaway inflation in developing countries such as Venezuela. This article examines three frequent mistakes that accountants make regarding the reporting of foreign currencies.Avoiding these pitfalls can make a big difference to companies’ financial statements.The first common mistake is difficult to detect without knowing how the accounting system consolidates subsidiaries.This mistake occurs when a company misclassifies a foreign-currency gain or loss in OCI instead of net income.Such a misclassification sounds benign, but it misstates net income and hides the gain or loss in an account that is normally presented as part of the statement of changes in equity.
Solely because of the change in the exchange rate, the company’s intercompany accounts (prior to any currency translation adjustments) no longer balance, as shown in Exhibit 2.Therefore, the German subsidiary must adjust its liability to Parent Company A from €6,961,000 to €7,433,000.The subsidiary will credit its liability for €472,000.The question is how the German subsidiary should record the offsetting debit to this transaction.The common mistake is to record the debit side of this transaction as part of the currency translation that is included in OCI.Generally, the debit side of this transaction should be included in net income rather than only as a component of OCI.There is one exception to the general rule, however.Foreign-currency gains and losses on intercompany accounts that are essentially permanent are excluded from the determination of net income and instead are recorded as OCI.In essence, if the intercompany account is essentially a permanent investment in the subsidiary, the gain or loss on that account should be excluded from net income.Unless the intercompany account meets this narrow exception, foreign-currency gains and losses on intercompany accounts should be included in determining net income.Normal intercompany accounts will generate a gain or loss that is ordinarily reflected on the books of the subsidiary operating in a functional currency other than the reporting currency of the parent company.