Choosing YTD vs Monthly Exchange Rates to translate your P&L

YTD vs Monthly Average exchange rates to translate your P&L

This is a question we get asked. A lot. There are two main ways in which people are translating their P&L into other reporting currencies.

1.       Translating each month’s results using that month’s average exchange rate

2.       Translating the YTD (year-to-date) P&L using the YTD average exchange rate

Well, what does IAS 21 say?

IAS 21.39 states that “income and expenses for each statement presenting profit or loss and other comprehensive income (i.e. including comparatives) shall be translated at exchange rates at the dates of the transactions;”

IAS 21.40 also states that “For practical reasons, a rate that approximates the exchange rates at the dates of the transactions, for example an average rate for the period, is often used to translate income and expense items. However, if exchange rates fluctuate significantly, the use of the average rate for a period is inappropriate. “

Whoever came up with paragraph 39 was clearly smoking their socks. Based on our boots on the ground experience, most ERP systems just don’t have the capability or processing power to translate every single transaction using its very own rate. Perhaps this might change in future but for now it cannot be practically implemented.

What paragraph 39 does do, is leave the door open for the requirement to translate material P&L transactions using actual transaction date exchange rates, like dividends received which is widely done in practice.

Nowhere though does it state that you should use either a monthly average or a YTD average exchange rate. Below are some great examples of how different your numbers can look whether you choose to use a monthly average or a YTD average.

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As you can see from the above examples, the difference in the type of rate you use can lead to a materially different result and is most pronounced when translating a business that is cyclical or seasonal in nature, like an agricultural business or one that is dependent on the weather or seasons.

In our opinion, the monthly rate would be more appropriate when translating the results of a seasonal business as it would more closely reflect the earnings at the time that they were made.

Crucially, whatever method you use will get baked in for future periods so make sure you choose wisely. You can’t flip flop between YTD and monthly rates to suit your desired outcome.

Why YTD rates are a terrible idea when consolidating monthly

This only affects you if you’re preparing monthly consolidated results for your group, which most groups do.

In the example below you’ll see why YTD rates are not ideal for use when translating results in your monthly consolidation.

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Which is the crux of why using YTD averages to translate your monthly results is so horrible. You’re either:

1.       Translating February using a rate that’s affected by January’s movements OR

2.       You’re effectively retranslating previously reported results (i.e. January’s results by including it in YTD values with YTD exchange rates)

Some people choose to use YTD exchange rates to translate their monthly results because that’s the policy for their financial statements. Your YTD rates are ultimately derived from the monthly rates, so there is no reason why you shouldn’t use the monthly rates to translate monthly results, and the final YTD exchange rate used in preparing your AFS can come from those monthly rates.

When to use transaction date exchange rates

We’ve spent most of this article looking at YTD vs monthly average rates. But there are scenarios in which you need to use the actual exchange rate related to a specific transaction.

The rule of thumb here is when a single transaction is material to your results you should translate that transaction using the actual exchange rate of that transaction. The best and most obvious transaction is dividends received. Dividends are normally material and also happen fairly infrequently which means they can’t get averaged out or diluted by other transaction (like revenue) which means you should be translating those using the exchange rate on the day the transaction was recorded.

But this rule can and should apply to all material transactions in your P&L.

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