Foreign Currency Effects on Business
Imagine taking a vacation trip to Europe and you decide to purchase souvenirs for no more than one hundred dollars. While browsing the store you find several souvenirs totaling one hundred Euro’s and proceed to the cashier to checkout. Scanning each item the cashier then says your balance is one hundred Euros, and you hand him one hundred US dollars. Immediately the cashier asks you for thirty six more dollars, which you give him. While leaving you may think to yourself why did I have to pay an extra thirty six dollars, and the answer is because foreign currency has a different value for some countries. Foreign currency is the money of another country. Each currency has an different exchange rate when compared to another, for example currently one US dollar is equivalent to seventy three cents in Euro’s. How does foreign currency effect the accounting of companies doing business globally? In this article we will examine the impact of foreign currency in accounting.
Foreign currency translation gains represent a large amount of companies profits. A countries exchange rate is affected by the economic factors effecting supply and demand of that countries currency. Factors such as investments, interest rates, amount of debt and others are a few examples. Being that countries have currencies that are not equivalent to each other most businesses find that outsourcing and creating businesses that are in foreign countries can help boost profits.
Currently international business has grown and countries like the United States are increasingly expanding their companies into foreign countries. The first step in this complex process is the company must change their accounting records from foreign GAAP to US GAAP. Next, would be to translate the foreign currency into the US Currency. One impact this has is these companies have to restate the values of their foreign financial transactions into the US currency values in order to record the transactions on their books. If foreign transactions were not recorded in this manner then many businesses can take advantage of this and manipulate the books to show a loss every year resulting in inflation of company profits. Companies would appear as a secure investments, and entices investors to believe this is a great stock purchase.
Foreign currency translation can have significant effects on every aspect of the financial equation. The effect of this currency exchanged may go beyond just the balance sheet. Companies these days have a plug in their financial statements called currency translation adjustment which can appear on the balance sheet, statement of net income, or the owners equity section. This plug helps the debits equal credits. Now if a company decided to have businesses in multiple foreign locations this will create a tougher task interpreting the information because the accounting records would involve multiple currencies on the financial statements. An example of this would be an increase in assets which could come from sales increasing, or the value of that foreign currency increasing but there would be no way to be certain about this unless it is investigated further.
Also, doing business in a foreign country may bring some unfavorable risks. The risk transactions associated with foreign business play an intricate part of the whole process. During the restatement of foreign currency into the US dollar if the US currency is weak the exports may show a gain but imports may show a loss and vice versa if the dollar was strong. The risk in the translation of financial statement occur when the dollar weakens Net assets will appear to have a gain while liabilities will appear to decrease, and the contrast will be true for the strengthening of the dollar.
These risks can be hedged in many ways. Some options of hedging include foreign currency hedging, forward exchange contracts, and others. In a foreign exchange contract hedge, a company transfers the risk to the investing company. For example, a US business may take out a bank loan from the country they are currently operating business. The amount of the loan is then converted into US dollars at the time of transaction.
Foreign currency can impact a company in different ways. It can be a risk to a company when not treated properly, but with the proper knowledge and execution of hedging and other methods international business can be a very effective.