Translation adjustments definition
/What are Translation Adjustments?
Translation adjustments are those journal entries made during the process of converting an entity’s financial statements from its functional currency into its reporting currency. These adjustments are made by a corporate parent when it has received financial statements from a subsidiary that use a different currency than the reporting currency of the parent. The adjustments are needed so that the parent can produce consolidated financial statements.
Presentation of Translation Adjustments
Foreign currency translation adjustments are stated as a separate line item on the statement of comprehensive income. A sample line item that contains this adjustment appears in the following exhibit.
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Example of Translation Adjustments
As an example of translation adjustments, a U.S.-based multinational corporation, GlobalTech Inc., has a subsidiary, EuroTech GmbH, located in Germany. EuroTech GmbH prepares its financial statements in euros (EUR), while GlobalTech Inc. reports its consolidated financial statements in U.S. dollars (USD).
At the end of the year, EuroTech GmbH reports the following balances in euros:
Assets: €10,000,000
Liabilities: €4,000,000
Equity: €6,000,000
The exchange rate at the beginning of the year was 1 EUR = 1.10 USD, and at year-end, it changed to 1 EUR = 1.05 USD. GlobalTech Inc. must translate EuroTech GmbH’s financial statements into USD using the current rate method, where:
Assets and liabilities are translated at the year-end exchange rate (1.05 USD/EUR).
Equity is translated at the historical exchange rate (when equity was initially recorded).
Revenues and expenses (not shown in this example) would be translated at the average exchange rate for the year.
Step 1: Translate Assets & Liabilities
Assets: €10,000,000 × 1.05 = $10,500,000
Liabilities: €4,000,000 × 1.05 = $4,200,000
Step 2: Translate Equity
Since equity is translated at historical exchange rates, let’s assume the historical rate was 1.10 USD/EUR:
Equity: €6,000,000 × 1.10 = $6,600,000
Step 3: Identify the Translation Adjustment
In the translated financial statements, assets must equal liabilities plus equity. However, using the current exchange rate for assets and liabilities and a historical rate for equity creates a difference:
Total Assets of $10,500,000 - Total Liabilities of $4,200,000 = $6,300,000
However, the translated equity (using the historical rate) is $6,600,000, meaning there is a translation adjustment of -$300,000.
Step 4: Record the Translation Adjustment
The parent company, GlobalTech Inc., records the translation adjustment as a component of Other Comprehensive Income (OCI) in the consolidated financial statements. The journal entry is:
Debit to Cumulative Translation Adjustment (OCI) of $300,000
Credit to Foreign Currency Translation Gain/Loss of $300,000
This negative adjustment reflects the fact that as the euro weakened against the U.S. dollar, the value of EuroTech GmbH’s assets and net equity decreased when translated into USD.