Remeasurement vs Translation

The distinction between remeasurement and translation is one of the more technical and frequently misunderstood aspects of foreign currency accounting. Both processes convert financial statement amounts from one currency to another, but they differ in their purpose, methodology, and income statement impact.

Remeasurement is required when an entity's books of record are kept in a currency other than its functional currency. This situation arises when, for example, a subsidiary in Brazil (functional currency: US dollar) maintains its books in Brazilian reais. The remeasurement process converts the reais-denominated records into US dollars — the functional currency — before any further translation into the parent's reporting currency occurs. The remeasurement methodology distinguishes between monetary and non-monetary items. Monetary items — cash, accounts receivable, accounts payable, notes payable, and other items settled in a fixed number of currency units — are remeasured at the current exchange rate (spot rate at the balance sheet date). Non-monetary items — inventory, property plant and equipment, goodwill, prepaid expenses, and deferred revenue — are remeasured at the historical exchange rate in effect when the item was originally recorded. Income statement items are remeasured at average rates for the period, except for items related to non-monetary balance sheet items (such as depreciation on fixed assets or cost of goods sold from inventories), which are remeasured at the historical rates of the underlying asset. The net remeasurement gain or loss flows through the income statement.

Translation, by contrast, is required when an entity's functional currency differs from the parent's reporting currency. The entity has already prepared financial statements in its functional currency; translation converts those statements into the parent's reporting currency for consolidation. The methodology is simpler: all assets and liabilities are translated at the current exchange rate, all equity items are translated at historical rates, and all income statement items are translated at the average rate for the period. The plug — the amount needed to make the translated balance sheet balance — is the cumulative translation adjustment (CTA), which resides in AOCI on the consolidated balance sheet and is not recognized in income until the foreign operation is disposed of.

For investors, the key takeaway is that companies with subsidiaries whose books are kept in a currency other than the functional currency will experience remeasurement gains and losses that directly affect reported earnings, creating volatility that can be difficult to predict. Translation adjustments, being relegated to OCI, do not affect reported earnings per share but do affect book value and are an important component of total comprehensive income.