Planning and Reporting a Currency in Forex
Properly, the cost of the currency value changes, when dealing in Forex, should be applied to the period prior to the date of the change. For example, to show as a single figure a large loss in results for 1967, due to the devaluation of sterling, essentially means that profits from sterling operations prior to that date were overstated.
If the accounts were restated, the loss could, with hindsight, be spread back over an appropriate period of time.
There are two ways in which the situation can be taken care of. One is to use a rate other than the going one for the translation of some, or all, of the profit and loss accounts. As an example, capital assets have a constant value in terms of translation into another currency, and that depreciation retains the constant value. Other accounts might be treated in the same way.
If one currency is weak in relation to another, but its value has been supported by the central bank, it might be entirely appropriate to use a free market rate of some sort, rather than the official market rate. Choice of the rate is particularly important in planning and budgeting for future periods.
Use of a lower rate for later periods may clearly indicate that price changes must be instituted to maintain the level of results evaluated in terms of another currency.
The second area in which planning should be done is that of providing reserves from current income for future losses from expected currency value changes. Such reserves are generally not tax deductible, but changes in values that result from translation of assets and liabilities in foreign currencies also are not tax deductible, so that all that is changed is the timing of the deduction.
Reserves may be provided on a general basis, or against particular accounts. They can be provided by the local company in terms of local currency, by the affiliated company at the time the results are translated, or by the affiliated company on its own books.
The provision of reserves should be considered in conjunction with the possibility of forward coverage, and the management of the networking capital exposed to currency changes. The costs of forward coverage should be evaluated against the probable exposure and self-insurance for the risk, in the form of reserves considered as an alternative.
Appropriate planning in that area, and in the pricing area, is essential to avoid losses and properly manage operations in other currencies. A thorough understanding of the methods used in translating assets and liabilities is essential for a proper evaluation of operations in other countries.
There are choices of methods, and the ones adopted should be suitable to the needs of a particular business. Once the methods are selected, the assets and liabilities (and the business as a whole) can be managed to minimize the effect of fluctuations in foreign exchange.