Accounting for Foreign Currency - Translating Functional Currency into Reporting Currency

Main ideas / lessons

• The purpose is currency translation: convert financial statement amounts from a company’s functional currency into its reporting currency.
• Translation is applied differently to income statement items vs balance sheet items, which can create currency translation adjustments (gains/losses).
• Most balance sheet accounts are translated using the spot/current rate, while certain equity components use historical rates or historical rolling averages.
• The translation differences flow into Other Comprehensive Income (OCI).

Methodology / instructions (step-by-step)

1) Translate the Income Statement (simpler approach)

• Use an average exchange rate for the period (e.g., for the month).
• Apply that same average rate to all income statement items (revenue and expenses).

Example given (rent expense):

• Rent expense (functional currency): £1,000
• Average rate for the month (GBP → USD): 1.3
• Translated rent expense (reporting currency): £1,000 × 1.3 = $1,300

Note: Using the spot rate at transaction dates is also acceptable, but the instructor’s practice used average rates.

2) Translate the Balance Sheet (with key nuances)

General rule

• Translate most balance sheet accounts at the spot/current rate as of the reporting date.

Example given (rent payable):

• Rent payable (functional currency): £1,000
• Spot/current exchange rate at financial statement date (12/31/22): 1.35
• Translated rent payable (reporting currency): £1,000 × 1.35 = $1,350

Why a translation adjustment occurs

• The income statement used an average rate ($1,300), while the balance sheet used a spot rate ($1,350).
• This mismatch creates a gain/loss, which is recorded in Other Comprehensive Income (OCI).

3) Balance sheet exceptions / nuances (equity accounts)

A) Capital contributions

• These remain at the historical rate when the capital was originally contributed.
• They do not change with later spot rates.

Example given:

• Capital contribution: £1,000
• Contributed on 12/31/21
• Rate then: 1.2
• Translated amount stays: £1,000 × 1.2 = $1,200
• Future changes in exchange rate do not affect this amount.

B) Retained earnings and dividends

• Retained earnings are described as using a historical rolling average concept.
• The idea: because net income was translated using monthly average rates, the accumulated retained earnings effectively becomes a blend of historical average-rate translations over time.

What the video conveys (conceptually):

• Each month’s net income is translated at its own average rate.
• Those translated results accumulate year over year.
• When retained earnings are translated on the balance sheet, they remain based on that historical rolling average (not a single current spot rate).

Speakers / sources featured

• Patrick (referenced by name in the subtitles as “Patrick’s got the wrong rates”; the speaker is implied to be Patrick.)