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Forex translation and cash flow statement

9 May 2009 8,537 views 3 Comments

Dear all,

I have to translate the financial statements from local currency (not a hyperinflationary economy) in EUR according IAS 21 (EUR is presentation currency) for a stand-alone company (no consolidation needed) for the first year of activity (no openings).

Income statement is translated at the average exchange rates (sum of each month separately).

Balance sheet is translated at the closing rate (end-of-the-year exchange rate) for all items (including fixed assets and equity).

First case:

The equity contains the net profit/loss (already translated at the average exchange rates). To obtain the balance it result a “translation adjustment”.

IAS 21 – 39 c “all resulting exchange differences shall be recognised in other comprehensive income”


IAS 21 – 41 “The exchange differences referred to in paragraph 39(c) result from:

(a) translating income and expenses at the exchange rates at the dates of the transactions and assets and liabilities at the closing rate.

(b) [… ]

These exchange differences are not recognised in profit or loss because the changes in exchange rates have little or no direct effect on the present and future cash flows from operations. The cumulative amount of the exchange differences is presented in a separate component of equity until disposal of the foreign operation …”


It seams to be quite clear that the translation adjustment is a BS element but my auditor (one of the big 4) asks me to apply the closing exchange rate also to the accumulated deficit element from equity. In that manner, BS is closing (assets = liab + Sh equity) and the translation adjustment is not a separate element in BS, it is included in P&L result. The IAS 21 is not respected.

Q1: am I right or it is something that I do not understand?

Second case:

Let assume that the translation adjustment obtained after the translation of P&L and BS is 20 EUR (irrespective of the placement: P&L or BS).

The next step is to do the cash flow statement (indirect method).

The main problem is that the indirect method uses the BS items (except from first line – “Profit/Loss”), items that are translated at the closing rate. In this way, it looks like IAS 7 is not respected (it is not used the spot rate or the average rates for the transaction).

If average rates are used, the elements of the cash-flow do not reconcile with the BS elements (i.e. the share capital in BS is 100 but in cash-flow the increase in the share capital is 105, and so on). More than that, the cash-flow bottom line has to be the same with cash from BS. After that type of translation, the translation adjustment will be different in cash-flow (i.e. 25) than that from BS.

My personal feeling is that for indirect method is applied the cash-flow has to be simply recomputed from P&L and BS and not to translate the cash-flow from local currency to the presentation currency. By doing this all the 3 financial statements reconcile perfectly.

Q2: which method is correct?





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