Why was there so much controversy over currency translation methods for group

accounting? Which method do you prefer?

Controversy in accounting standards generally seems to arise between preparers (company
management) and the standard-setters. Only in extreme cases do the government, the press
or user groups become seriously involved. Academics can usually be relied upon to provide
arguments, but generally on at least two sides. Controversy from management relates to extra
disclosures, extra costs or a change to values or profit measures. In this case, most of the
argument seems to relate to profit measurement. It is particularly in the United States that the
controversy has been greatest. This is because most other countries fall into two categories:
those where consolidation of overseas subsidiaries was traditionally unimportant and where
taxation is an important influence in accounting so that group accounts were of little interest
(e.g. Japan, Germany); and those who generally followed US practice (e.g. Canada, and many
other countries to a lesser extent). In the United States, the problem seems to be that
standard-setters have tried to establish theoretically coherent practice. By contrast, the United
Kingdom standard-setters steered clear of the subject until the 1980s and then allowed current
practice to continue, with a variety of options.
The history of US statements on currency translation is lengthy and is examined in the text.
SFAS 8 of 1975 established the theoretically neat model of the temporal principle, which can
be called the temporal method when applied to historical cost accounting. This method relates
the choice of translation rate for any item or balance to the timing of its valuation basis. This
results in assets being valued at historical cost both before and after translation (i.e. in both
the subsidiary’s and the parent’s currency). By contrast, the current rate method causes
translated assets of subsidiaries with depreciating currencies to disappear gradually.
The problem with the temporal method is that it generates losses (in the group income
statement) when the parent’s currency is weak. Consequently, the temporal method led to
greater volatility of profits, and in particular to losses when the dollar was weak in the late
1970s. These losses occur even if the subsidiary has matched overseas loans with overseas
assets. This difficulty led to massive complaints from management, followed by a move to the
current rate method in SFAS 52. Because it is particularly obvious that the current rate method
gives ridiculous results when there are large exchange rate movements, the temporal method
is still to be used for subsidiaries in highly inflationary countries (100 per cent or more,
cumulatively, in three years). The fundamental problem is that exchange rate movements are
linked to price changes. While accounting generally ignores the latter, any recognition of the
former creates insuperable measurement difficulties.
There are several further arguments in favour of the current rate method to be found in various
UK or US exposure drafts and standards. These are dealt with in the chapter, and most of
them seem to be ‘excuses’.
In terms of quality of information for users of financial statements, the temporal method without
gains and losses going to income might be the best. This was used by some German
multinationals. Otherwise, it is a question of which faults are least worrying. Of course, if
current value accounting were used, most of the problems of currency translation would go
away.
Incidentally, this answer has been written on the assumption that the question concerns the
translation of the financial statements of foreign subsidiaries. The other issue would be the
translation of transactions or balances in foreign currency in an individual company’s financial
statements, which are carried through to group accounts. There is some controversy here,
particularly concerning whether unsettled gains can be taken in income.
Why has it been difficult, particularly in the US, to create a satisfactory accounting
standard on foreign currency translation?
The United States seems to have originally looked for theoretical coherence, but this is a
hopeless task in the context of historical cost accounting. If one ignores price changes but
tries to adjust for exchange rate changes, the arithmetic will not work because the former help
to cause the latter.
The UK seems to have adopted simple and pragmatic approaches.
France and Germany have been relaxed about the issue because relatively few companies
are concerned and there are no tax effects. The Seventh Directive steered clear of this issue
because it was controversial (for example, the UK liked the closing rate method and the
Germans liked the temporal method) and because several countries were happy with silence
on the subject (including the UK).
IAS 21: Factors to consider when determining the functional currency for an individual
company

 The currency that mainly influences sales prices for goods and services;
 The currency that mainly influences labour, materials and other costs of providing
goods and services
 The currency in which funds from financing activities are generated and the currency
in which the receipts from operating activities are usually retained, which also provide
evidence of an entity’s functional currency.
Factors a parent considers when deciding with a subsidiary on the subsidiary’s
functional currency
1. Whether the activities of the foreign operation are carried out as an extension of the
reporting entity, rather than being carried out with a significant degree of autonomy.
An example of the former is when the foreign operation only sells goods imported from
the parent and remits the proceeds to it. An example of the latter is when the operation
accumulates cash and other monetary items, incurs expenses, generates income and
arranges borrowings, all substantially in its local currency.
2. Whether transactions with the parent are a high or low proportion of the foreign
operation’s activities.
3. Whether cash flows from the activities of the foreign operation directly affect the cash
flows of the parent and are readily available for remittance to it.
4. Whether cash flows from the activities of the foreign operation are sufficient to service
existing and normally expected debt obligations without funds being made available
by the parent