Last October the Financial Accounting Standards Board released Statement No. 8, which deals with translation of financial statements of foreign subsidiaries. The new rules will obsolete accounting methods used by two-thirds of American-based multinationals and alter the translation gains and losses in many 1975 annual reports.
Whether a given set of translation rules results in a gain or loss is a matter of which accounts the rules cite for translation at the current exchange rate. Under the rules in Statement No. 8, except for inventory consumed in cost of goods sold and depreciation, the subsidiary’s income-statement items are translated into dollars at the exchange rate prevailing at the time transactions occur. Balance-sheet items are translated at the exchange rate that prevailed when the item was acquired, with owners’ equity taken to be whatever number will balance the assets and liabilities.
Under Statement No. 8, the accounting exposure of a foreign subsidiary will often differ from the economic exposure: Many people believe, for example, that when the country in which a subsidiary is located devalues, the result in general is an economic loss to the parent. Yet the definition of gains and losses in Statement No. 8 is such that, if the subsidiary is levered, a devaluation of the local currency will result in translation gains.