When restating foreign accounts for foreign inflation, firms at times double-count for the effects of inflation, the double-dip. This challenge exists for the reason that local inflation directly affects the exchange rates utilized in translation. Even though economic theory assumes an inverse relationship among a country’s internal rate of inflation along with the external value of its currency, evidence suggests that this relationship seldom holds (no less than in the short run). Accordingly, the size with the resulting adjustment to eliminate the double-dip will vary depending on the degree to which exchange rates and differential inflation are negatively correlated.
As noted just before, inflation adjustments to price of sale or depreciation expense are created to minimize “as reported” earnings to stay away from overstating earnings. However, due to the inverse relationship in between nearby inflation and currency values, adjustments within the exchange rate in between successive financial statements, commonly brought on by inflation (at the very least over a period of time), will make at least portion in the impact of inflation (i.e., currency translation adjustments) have an effect on a company’s “as reported” results. Therefore, to stay away from adjusting for the effects of inflation twice, the inflation adjustment need to take into account the translation loss already reflected in a firm’s “as reported” outcomes.
This adjustment is relevant to U.S.-based multinational corporations (MNCs) that have adopted the dollar as the functional currency for their foreign operations under FAS No. 52 and that translate inventories making use of the existing exchange rate. It's also germane to non-U.S.-based MNCs that recognize translation gains and losses in current earnings. Absent any offsetting adjustments, such corporations could lessen or raise earnings twice when accounting for foreign inflation. The following inventory accounting example shows the relationship between inflation and foreign currency translation. The provider in question makes use of the FIFO inventory costing approach and translates inventory to dollars at the existing exchange rate.
SEE ALSO:
MANAGEMENT INFO AND HYPERINFLATION
Translation Accounting Development
CURRENCY TRANSLATION TEMPORAL APPROACH
