Do you know how much of your Profit/(Loss) is from Operations or Currency Translation?

By Sigma Conso, a Prophix Company

Accountant calculating profit with financial analysis graphs 74855 4937

What we’ll be talking about:

  • As per IAS21 'Effect of Changes in Foreign Currency Rates', companies are to translate all Assets and Liabilities using the Closing Rate.
  • Companies operating with multiple currencies will face challenges and additional work in consolidation procedures.
  • Foreign currencies transactions are recognised at different rates due to various factors.
  • Monetary and Non-Monetary items will use different rates as required; current market rate, closing exchange rate or historical exchange rate.

Are you interested in discovering more about financial consolidation and reporting software? If so, please get in touch. We have a team of experts who will be happy to discuss your specific needs and what our CPM software can do for you.

How is your company operating?

These days companies develop foreign activities for many reasons. When they do, they transact in many currencies. Today we will explore how to assess if a company's Profit/(Loss) is a result of Operations or from Currency Translation. When there are transaction(s) in foreign currency(ies), the resulting impact of constant conversion to the local currency will affect the profit or loss, which, sometimes can be significant. Working concurrently with which currency to utilise, the company will also need to determine the exchange rates at the time the account is being translated.

For instance, we will use the scenario of a Malaysian manufacturing company (operating as the
Parent with subsidiaries in Singapore, Indonesia, Vietnam, and Thailand). The subsidiary operating in Vietnam purchased materials from the Parent in Malaysia, makes semi-finished products locally and then sells the semi-finished products to another company in the group, i.e. Thailand.

The Parent uses the local company in Vietnam as a production company due to lower labour costs. Both purchases and sales were made in MYR in the past. However, the main and only customer of the local company changed during the period due to group structure changes. As a result of that change, the local company continued to purchase raw materials in MYR, but invoiced 100% of its sales in IDR because the new customer insisted on IDR pricing. The local company may now be in a position where the management has to determine if there should be a change to its functional currency.

What currency are you using?

As a note, do you know that there is a difference between the Functional Currency and the
Presentation Currency? Functional currency is the currency of the primary economic environment in which the entity operates. It is the entity's own currency and all other currencies are "foreign currencies". Presentation currency is the currency in which the entity presents its financial statements. The functional currency is NOT a matter of choice, but a matter of its economic environment, while the presentation currency is any currency that the entity chooses.

The entity in Vietnam can decide to present its financial statements in a currency different from its functional currency but before consolidation procedures, the entity will need to translate its financial statements to the Parent’s Presentation currency.

As per IAS21 'Effect of Changes in Foreign Currency Rates', companies are to translate all Assets and Liabilities using the Closing Rate. At initial recognition, all foreign currency transactions shall be translated to functional currency by applying the spot exchange rate (current market rate) at the date of transaction. Later reporting (at the end of each reporting period), all *monetary items in foreign currency will use the closing exchange rate. **Non-monetary items in foreign currency carried at historical cost will use the historical exchange rate (at date of transaction). Non-monetary items in foreign currency carried at fair value will use the exchange rate at the date when the fair value was determined. Any differences arising between the historical rate and Closing Rate will be recognised to the FCTR.

Why is this important?

For the Malaysia Parent and its subsidiaries (or any companies operating with multiple currencies), there are many factors to consider as market conditions are volatile these days, one of which is the on-going invasion of Russia into Ukraine affecting economies worldwide. Environmental factors will also affect the prices of commodities, pushing companies to think about their inventories on-hand and stocking up to avoid price fluctuations due to unpredictable market condition.

When the above has been carefully reviewed and considered, you will then be able to ascertain if your company's profit or loss’ result was mainly due to Operations or from Foreign Currency Translation, and steer the company into the right direction to avoid major financial impact.


*Monetary items such as Trade Receivables, Trade Payables, Pensions to be paid in cash
**Non-Monetary items such as Property, Plant & Equipment, Inventories, some prepayments.

Are you interested in discovering more about financial consolidation and reporting software? If so, please get in touch. We have a team of experts who will be happy to discuss your specific needs and what our CPM software can do for you.