Foreign currency translation reserves are a type of capital reserve. It arises when a business has foreign offices. This office could be a branch, subsidiary, or joint venture. No matter the case, there is a need to calculate it when the reporting entity has a different functional currency from its other offices in another country.
Definition of Foreign Currency Translation Reserves
1. Foreign currency translation reserves are the differences that arise from translating the currency of a company’s foreign offices to its local currency when preparing and presenting financial statements.
2. It can also be defined more formally as the gains or losses arising from translating the functional currency of a company’s foreign offices to that of the reporting entity at the end of an accounting period.
Foreign offices. A business in Nigeria may have offices in Ghana, Kenya, and South Africa. The offices might be a foreign branch, subsidiary, or joint venture. The foreign branch is another standalone economic entity in another country that’s performing similar or other activities with the head office. That means, if the head office sells banking services, the branches do the same. Or may own other types of businesses located in another country.
For foreign subsidiaries, the reporting entity owns a controlling interest in it. For example, company A in Nigeria may purchase 55 percent shares of company B in Ghana. This makes company B a subsidiary. In the case of the joint venture, the reporting company is doing business with another entity(ies) outside its economic border.
Reporting entity. The company preparing and presenting the financial statement is the reporting entity. The accountant needs to merge the trial balance of all its offices outside the country. He or she will do this by translating the trial balances and financial statements of the other offices’ currencies to the local ones. He must apply the principles in IAS 21 (Effect of changes in foreign currency rates).
Functional currency. This is the currency of a firm that can function as an independent economic unit. A branch outside the country can function on its own. As well as prepares its accounting record by itself. If this is true, then it must use its local money. For example, a Nigerian company that has a branch in the United Kingdom will allow it to prepare its books of accounts in British Pounds.
Gains or losses. Gains lead to foreign currency translation reserves in the balance of the entity. And are treated as liabilities in the balance sheet and posted to the other comprehensive income. Loses reduce this reserve.
Foreign currency translation reserves are the result of a company that owns foreign offices. Those offices prepare their trial balances and financial statements in their local or functional monies. However, the reporting entity or head office will need to translate the trial balance and financial reports to its local currency. In doing so, it must comply with International Accounting Standards (IAS) 21.