By: Lauren Horneff, CPA, MBA, CMA, CFM
Be it market expansion, resource acquisition, risk management, or some other reason, many nonprofit organizations engage in foreign activities. These can include foreign vendors, members or chapters based in other countries, foreign bank accounts, foreign branches, and foreign subsidiaries/affiliates. In this article, we’ll take a look at some of the business, legal, and economic factors involved in going international.
Let’s begin with everyone’s favorite topic—taxes. Being tax exempt in the United States does not necessarily mean you will be tax exempt around the world. In addition, if you do happen to be tax exempt in a foreign country, you must determine from which taxes you will be exempt: income, payroll, value-added, property, etc. Further, on what level will you be exempt—national and/or local? Finally, you’ll also want to determine how your taxes in the United States would be affected at federal, state, and local levels. As you can see, the taxation of the international operations can get complex.
Next, let’s talk about cash management. How do you want to manage the cash in the foreign bank account? Do you want to keep an approximate balance in the account, or do you want to minimize the balance in the foreign account? Foreign exchange rates become a factor on your statements of activities and cash flows. And not only will you need to learn the different banking regulations in each country, you will also need to learn the differences in the accounting principles of the foreign country versus U.S. accounting principles. Finally, other business factors that could significantly affect the finances are labor, competition in the foreign market, and technological factors.
Okay, so now that you have foreign activities, how do you account for these? There are two primary issues in accounting—foreign currency exchange transactions and foreign currency translation.
A foreign transaction gain/loss is the difference in exchange rates between the date on which the transaction occurs (i.e., the revenue is earned or the expense is incurred) and the date on which the cash is exchanged. For example, assume your reporting currency is U.S. dollars, but you buy something at €5,000. At that date, the exchange rate is €1 = $1.23. You would record the purchase at $6,150 (€5,000 * $1.23/€) by debiting an expense and crediting accounts payable. Thirty days later, you pay the invoice in euros. The exchange rate at the pay date is €1 = $1.27. Accordingly, you actually pay $6,350 (€5,000 * $1.27/€) in cash for the purchase, and you’d record it by debiting loss on foreign currency transactions for $200, debiting accounts payable for $6,150, and crediting cash for $6,350. If your reporting date is between the transaction date and pay date, you would update the payable using the exchange rate at the reporting date through the gain/loss on foreign currency transactions account.
Foreign currency translations are a bit more complicated. It is when you convert financial statements based in a foreign currency to the reporting currency. A translation is usually performed when there is a foreign subsidiary, and its books are kept in a foreign currency. In its simplest form, performing a translation involves converting the balance sheet using the exchange rate at the reporting date and the statements of activities and cash flows at an average rate during the reporting period. The difference is the cumulative translation adjustment and is part of the unrestricted net assets balance. One thing to remember when you receive the financial statements from the foreign branch or subsidiary, you need to look at the accounting policies to ensure the accounting policies of the foreign financial statements are consistent with the accounting policies of the reporting entity.
In an ideal world, you would go through each single foreign transaction and record it separately. Unfortunately, this is not very practical. Instead, you can use a more practical expedient. For the balance sheet, the majority of assets and liabilities are translated using the exchange rate at the reporting date. There are some exceptions, but that goes beyond the scope of this article. For the statements of activities and cash flows, the transactions are generally translated using some average exchange rate for the period. There is no specific guidance on what constitutes an average rate as long as it is reasonable and reflects the timing of the transactions during the period. For example, you can use a daily or monthly average or even average the beginning and ending exchange rates. Some websites will calculate the average for you. You may also pull out very significant transactions and translate those separately. Finally, the beginning net assets must equal the ending net assets of the prior period. Any difference between the ending net assets per the balance sheet (i.e., translated assets less liabilities) and the total of the translated change in net assets and beginning net assets is the current translation adjustment and is generally reported as part of the change in unrestricted net assets.
See FASB Accounting Standards Codification 830, Foreign Currency Matters, or consult your auditor for additional information.
Lauren Horneff is a manager in Tate & Tryon’s Audit & Assurance Services department and can be reached at firstname.lastname@example.org.