Accounting and Foreign Currency Reporting

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Table of Contents

Introduction
The ‘True and Fair View’
Stewardship
International Reporting Standards
Foreign currency reporting
Off-balance sheet items
Conceptual framework
Conclusion
References

Introduction

In an economy, financial transactions are inherent. Companies and other entities need to communicate to the employees, the public and statutory administrative bodies about the transactions they perform which have financial implications. This need is precisely addressed by a language called accounting. (Horngren, et al., 2008).

The ‘True and Fair View’

Accounting could be highly subjective because of the many assumptions that are made in arriving at the figures that are presented in the financial statements. The debates in accounting are centered on the accounting images and ideologies.

One of the images accounting portrays is the ‘true and fair’ view. Accounting calculations rely upon theories and they make assumptions about the social world. Thus different people will prefer different methods of accounting for transactions, depending mostly on their interests. These theories are debatable and mostly influenced by those in power, either in the political scene or big corporations, who might have vested interests in the way financial statements are presented.

Accounting calculations also place emphasis on ‘finance capital’ and ignore the ‘human’ and ‘social capital’ which is necessary for wealth creation and it is therefore considered to be divisive. There is also the issue of whether transactions should be measured using historical values, fair values or market values. All these values will lead to a different profit and therefore the truth and fairness of the accounts can be disputed.

Stewardship

Stewardship might also raise issues as the owners and the managers of corporate entities are usually different. Shareholders who are the owners of a particular entity may have a long-term focus on the business and might therefore want a true and fair presentation of the financial statements to enable them make decisions as to whether to sell their stake in a company or hold it, depending on the presented performance. Their concern might be increasing their share prices whereas the managers might have a short-term focus of increasing profits in the current period so that they can get their bonuses and other benefits. This however might be to the disadvantage of the shareholders.

International Reporting Standards

Entities are usually governed by accounting standards, both at the national and international levels. Most countries are moving toward private entities being in charge of formulating standards instead of this very important role being left to public bodies and elected governments entities (Sikka, 2007). An example is the International Accounting Standards Board (IASB) based in London which is funded by the four major accounting firms’ and other big companies.

This means that the private sector has been left to advance its agenda and therefore they do not represent the interests of the ordinary people. The collapse of the giant company Enron happened under the watchful eye of IASB. These raised very many questions as to the suitability and integrity of IASB as a regulatory body and also the issue of integrity in carrying out its mandate. IASB has also included some clauses in its document that exempt it form liability to the public. It sates for example, that it does not owe a ‘duty of care’ to individuals. Thus any affected party cannot lodge a claim against them for non-performance. This leaves major loopholes in the way financial reporting is done and ends up making accounting highly subjective.

Furthermore, IASB requires that all major businesses follow its standards regardless of whether these standards are relevant to these businesses or not. These standards are also imposed on developing countries as conditions for granting aid and in turn the developing countries end up being controlled by the west. They follow their ideologies regardless of whether they are meeting their local needs or not. These standards are already failing in the west and there is no guarantee that they will work in developing countries.

Foreign currency reporting

Another issue is the way of dealing with foreign currency issues in financial reporting. Most large companies deal with foreign currency or have subsidiaries overseas and therefore the foreign currency issues in financial reporting needs to be addressed. Furthermore, exchange rates fluctuate and this poses a serious problem. Fluctuations in currency rates can affect all business and consumers directly or indirectly.

Direct effects occur where companies trade abroad or have subsidiaries overseas. Indirect effects can occur, for instance, if there is a change in the US dollar: £ sterling exchange rate which will affect the price of oil in the UK (since oil is priced in US dollars). There are objectives of foreign currency translation that are guided by SSAP 20 (para.2) which states that ‘the translation of foreign currency transactions and financial statements should produce results which are generally compatible with the effects of rate changes on a company’s cash flows and its equity and should ensure that the financial statements present a true and fair view of the results of management actions.

Consolidated statements should reflect the financial results of and relationships as measured in the foreign currency financial statements prior to translation’. The problem here is that there is the use of historic cost accounting and therefore there has to be a choice between a system that translates historic exchange rates and a system that uses the current exchange rate. As Demirag (1987, p.83) states ‘‘translated accounting information will not provide useful information until it is based on current value accounting’.

Another issue is how to account for future receipts and payments. A number of arguments have been put forward in favour of the closing rate; since the future rate is unknown, then the current rate is considered the best estimate. Others argue that forward rates, appertaining to date of settlement, be used. The gain/loss which results is post balance sheet, but under the prudence concept accounts are supposed to provide for foreseeable losses.

An argument here is that where forward rates differ from current rates this implies differential interest rates, and the gain/loss on say a loan arising from the change in exchange rate between balance sheet date and date of payment is the counterpart of the higher/lower interest which would be payable if the debt were denominated in the parent company currency. In other words, there is a problem in deciding whether differences are exchange rate differences or related to different interest rates.

With the profit and loss account, transactions are translated at rates ruling when the transaction was first recognised. So sales are translated at delivery. In principle each transaction should be translated separately, but in practice an average rate for the period is used. This might be weighted in the case say of a seasonal business. There are 2 exceptions: depreciation is calculated at the historic rate of the fixed asset while cost of sales is valued at the historic rate when required.

Off-balance sheet items

Off-balance sheet financing is a term used to describe the different methods used by companies when they want to exclude assets and liabilities from the balance sheets. This is sometimes known as ‘window dressing’ or ‘creative accounting’. Various factors are responsible for reporting on off-balance sheet items. One of the factors is the effect on gearing ratio. Doing away with debt from the balance sheet will make investors view the company as less risky and will therefore want to invest in such a company. Highly geared companies are perceived to be risky since any returns that are received will first go to pay the debtors and this might reduce the earnings to investors.

The off-balance sheet items could also affect the profit figure and especially where director’s salaries are tied to the profits, off-balance sheet schemes could increase their pay. Some off-balance sheet financial arrangements may also have beneficial effects from a tax viewpoint. Depending on the type of off-balance sheet financial arrangement, all or some of the effects mentioned above could be important.

Usually changes are generally cosmetic and will not change shareholder wealth immediately. An exception would be if management salaries were related to reported profits, such that the effect of artificially increasing reported profits would lead to a larger cash outflow to managers. However, an off-balance sheet financial arrangement which leads to a reduction in the tax charge will have a direct impact on cash flows and, therefore, shareholder wealth. There could be an indirect or delayed effect on shareholder wealth, if, for example, investors are fooled by purely accounting changes and buy or sell shares as a result.

Conceptual framework

There is also the debate on whether the conceptual framework is necessary in accounting or not. A conceptual framework (CF) is a coherent system of interrelated objectives and fundamental principles, a framework which prescribes the nature, function and limits of financial accounting and financial statements (ACCA, paper F7 INT, 2008/09).They suggest that Accounting theories are a tactic to buttress ideas put forward by interest groups.

Each will adopt theories to justify its own special pleading, and there cannot be a consensus on a CF. Diverse groups prevail in different circumstances or in the adoption of particular accounting treatments therefore there is no CF that will “fit” all the standards. There is also an argument that a CF would lead to rigidity and kill off initiative and innovation. There are also public choice problems and therefore in practice a decision would have to be made that the interests of one group of users, for a particular purpose, was paramount.

Conclusion

The foregoing arguments show the subjectivity of accounting, and especially because there is no one way of performing transactions. The same transactions can be reported in different ways and therefore end up giving conflicting results which might lead to issues of reliance on such statements. However, despite accounting subjective it remains the language used in business and thus we cannot do without some form of accounting, the benefits outweigh the costs.

References

ACCA, 2008. Paper F7-Financial Reporting (FR). Berkshire: Kaplan Publishing.

Demirag, I.S. 1987. A Review of the Objectives of Foreign Currency Translation. International Journal of Accounting, Education and Research, 22(2), pp.69-85.

Horngren, T., Sundem, L., Elliot, A. & Philbrick, R., 2008. Introduction to Financial Accounting. 3^rd ed. New Delhi: Pearson Education.

Sikka, P., 2007. There’s no accounting for accountants: the Guardian. Web.

Sikka, P., 2007. Unaccontable: the Guardian. Web.

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