Mergers and take-overs are commonplace in today’s market. As a result, the accounts of both companies must be combined. Yet, how are the accounts combined of two companies when one is in a foreign country? It is helpful first to define the exact relationship between the domestic and foreign company.
The methods used to translate the accounting of the foreign company depends on whether it is independent of its American parents or if the two companies are closely integrated. Those responsible for creating the financial statements are the ones to determine the foreign company’s classification.
In order to properly define the company’s relationship, the accountant must answer questions like the following. Where are the foreign company’s products sold? Does cash flow openly between the American and foreign companies? Where does the foreign company purchases its goods and services?
Once the foreign company has been defined as either independent or integrated, the next step is to translate the foreign currency amounts into American dollars.
- Independent Foreign Company
The accounts of an independent foreign company are translated at current exchange rates. The balance sheet dates determine the exchange rate in which all assets and liabilities are translated. An average exchange rate of the rates throughout the year is used for revenues, expenses as well as depreciation for that year.
- Integrated Foreign Company
The accounts of an integrated foreign company are handled like they had occurred in American dollars instead of the foreign currency. Intangibles, tangibles, plant and equipment and inventories are translated using the exchange rate at the time these items were obtained. Monetary items are translated at the current rate. Revenues and expenses are translated at an average rate of the rates in effect all year. Only depreciation and amortization of intangibles are translated using a historical rate.
Because different accounts are translated at varying rates, the accounts will not balance. The measure of the exchange gain or loss must be added to the account to produce a balanced account.