Don't Let Foreign Currency Fluctuations Impair Performance Measurements: Companies Need to Determine the Best Approach for Translating Financial Statements to Show True Operating Performance

[ILLUSTRATION OMITTED] The value of the U.S. dollar rose significantly from June 2014 to April 2015 compared with other foreign currencies. For U.S. companies with international operations, that could have resulted in reduced reported sales and net income. But the stronger dollar could also have had an impact on the companies' internal performance analyses. ASC Topic 830, Foreign Currency Matters, prescribes methods for translating foreign operations' financial statements into U.S. dollars for consolidation. But drawing operating performance conclusions from these U.S. GAAP-translated financial statements may result in the wrong conclusions and suboptimal decisions impacting future financial performance. For example, the U.S. dollar appreciated 17% against the euro from an average $1.3695 in the first quarter of 2014 to an average $1.1320 in the first quarter of 2015. Quarterly averages are the basis for translating foreign income statements under U.S. GAAP (Topic 830). This article ultimately shows that a constant-dollar income statement presentation may best illustrate true operating performance and disaggregate the impact of fluctuating foreign currency. U.S. dollars to buy one euro Weekly and average quarterly exchange rates show the trend of the U.S. dollars required to buy one euro from Jan. 1, 2014, through April 1, 2015 (see the chart Euro/Dollar Exchange Rate). Specific information for the income statement is in ASC Paragraph 830-10-55-11 and ASC Paragraph 830-30-45-3. Topic 830 requires translating income statement accounts at the foreign currency exchange rates on the recognition date for revenues and expenses. Because it might be impractical to use the current exchange rate for the dates that the numerous income statement elements are recognized, an appropriately weighted average foreign currency exchange rate for the period covered by the income statement may be used to translate those elements. The guidance also applies to accounting allocations in the income statement, such as depreciation, amortization, cost of goods sold from inventory, and deferred revenues and expenses. Thus, these allocations are required to be translated at the foreign currency exchange rates on the date they are included in revenues and expenses, and not the rates on the historical dates the related items originate. [GRAPHIC OMITTED] While Topic 830 is appropriate for financial reporting, better tools are available for assessing business performance. PERFORMANCE MEASUREMENT Consider a U.S. entity with operations in Europe. This company would translate its income statement using the average foreign currency exchange rate over the period covered in the income statement. U.S. GAAP-translated P&L The U.S. dollar income statement for the first quarter ended March 31,2015, of a company's operations prepared according to Topic 830 is appropriate for financial reporting purposes (see the chart European Operations P&L Translated Into Dollars). The income statement in the chart European Operations P&L Translated Into Dollars is not appropriate for performance measurement because it is not sufficient for reaching meaningful operating conclusions and, as a result, could lead to poor decisions with unfavorable consequences. The operating performance conclusions from this income statement are that sales of $15.2 million are below both budget and prior year. Income is relatively flat, coming in slightly above budget but slightly below the prior year. It appears that management may have positively reacted to the sales decline by aggressively reducing expenses. Because of U.S. GAAP's foreign currency guidance limitations for operating performance measurement, a more appropriate approach may be to evaluate operating performance using local foreign currency financial statements before translation into U. …

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