Unraveling the complexities of cumulative translation adjustments (CTA) in your financial reporting

The cumulative translation adjustment (CTA) is an integral part of financial statements for companies with global business operations and subsidiaries. A CTA entry is critical to helping investors and other stakeholders differentiate between actual operating gains and losses in the business and those generated solely from currency translation. 

In this article you’ll learn more about CTA including how to calculate and report CTA in your consolidated financial statements, and why it is important for your SaaS business.

What is a cumulative translation adjustment?

Cumulative translation adjustment (CTA) is an entry on a company’s consolidated balance sheet that summarizes the gains and losses resulting from varying foreign exchange (FX) rates over time. 

Calculating the CTA is part of the process of translating financial statements during consolidation and financial reporting from a foreign subsidiary’s local currency into the functional currency of the parent company.

CTA is reported in a line item typically called “Accumulated Other Comprehensive Income (AOCI)” in the equity section of a translated balance sheet. The FASB’s recommended title for this account is “Equity Adjustment from Foreign Currency Translation”. 

Fluctuations in FX rates over time can impact the value of a company's net assets. Thus,  adjustments are necessary when consolidating the financial statements of foreign subsidiaries into the parent company's financial statements. Let’s start with an example of a balance sheet without a CTA to illustrate why the adjustment is needed.  

Notice that the exchange rates used are not all the same. While all assets and liabilities are converted at the month-end FX rate, equity is converted using different rates depending on the type of equity reported:

• Shareholder’s capital is converted at the historical exchange rate for capital stock.
• Retained earnings are converted using the prior year’s average annual exchange rate.
• Current period earnings are converted using the average exchange rate for the month.

The use of different rates in the equity section of your balance sheet is why you need a CTA. Remember the balance sheet equation: 

The problem is, if you don’t use the same exchange rate to convert all three components of your balance sheet, your assets won’t equal the sum of your liabilities and owner’s equity. In short, your balance sheet won’t balance. 

Using different exchange rates for the different types of equity is necessary to accurately convey the changes in value. In the example below, you can see how adding a line item for the CTA solves the problem that doing so creates in your balance sheet. 

Consolidated exchange rates for financial reporting 

FX accounting includes the translating financial statements of foreign subsidiaries of a company into the parent company’s functional currency during consolidation. 

CTAs can be considered a subset of FX gains and losses. They are made on a company’s balance sheet to capture both cumulative and consolidated adjustments, accounting for FX gains/losses across different entities (consolidated) and cumulatively (over a period of time). 

Before we get into the specifics of consolidated exchange rates, it’s important to define some key terms associated with FX accounting that also apply to CTAs:

• Parent company: A company is referred to as the parent company when it has subsidiaries or operations outside of its primary operational environment (where it is registered and headquartered). 
• Functional currency:  A company’s functional currency is the currency of the primary economic environment, typically the main country, in which the parent company operates. Thus, you can think of it as the company’s “home currency”. 
• Foreign currency: The currency of its subsidiaries is known as foreign currency that must be converted and translated on the basis of exchange rates into the parent company’s functional currency.
• Reporting currency: The currency in which the company presents its financial statements and reports is known as the reporting currency. 

When creating consolidated financial statements, there are three types of consolidated exchange rates you can use to account for FX gains and losses. Each accounting period, accounting book (or books in the case of multi-book accounting), and subsidiary will have its own set of three consolidated exchange rate types. 

You can (technically) choose any exchange rate to calculate FX gains/losses during consolidation. However, it is important to be consistent with the calculation methodology to keep track of operational performance and avoid inadvertently manipulating your financial reports.

• Current rate: Also referred to as ending rate. This applies to most asset and liability accounts. This rate is the currency exchange rate that is effective at the end of the reported period. The current rate is commonly used when consolidating balance sheets because balance sheets represent a point in time, so the current rate at that point in time is usually the one that’s used.
• Average rate: Applies to all income statement accounts, such as income and expense. The weighted average of the currency exchange rates for all transactions posted during the period to accounts with a rate type of average. This rate is used to translate accounts in the income statement and to build retained earnings reported in the balance sheet.
• Historical rate: Same as average rates, except for accounts with a rate type of historical. This applies to accounts in the capital section of the balance sheet including equity and dividends. This rate is used for equity accounts and owners’ investments. 

Why cumulative translation adjustments are important

CTAs are an integral part of financial statements for companies with global business operations and foreign subsidiaries. 

For these companies, a CTA helps investors differentiate between [equity/assets] from actual operating gains and losses across each subsidiary of the business versus those generated solely from currency translation. This is important because foreign currency fluctuations can falsely inflate your business’s profits or losses. 

In addition, a global customer base can make SaaS businesses more vulnerable to FX risks and currency fluctuations, potentially impacting their revenue and profitability. This impact can become more pronounced at scale, as SaaS businesses expand and/or diversify their products and services  across geographies.

Unlike FX gains and losses that are recorded in the income statement, CTA is reported in a line item called “Accumulated Other Comprehensive Income (AOCI)” in the equity section of a translated balance sheet. The FASB’s recommended title for this account is “Equity Adjustment from Foreign Currency Translation”.

Standards that guide translation adjustments

U.S. Generally Accepted Accounting Principles (GAAP) Accounting Standards Codification (ASC) 830-30-45 provides guidance on how to translate of foreign currency in financial statements and transactions. 

The Financial Accounting Standards Board (FASB) also provides a summary of this guidance in its Summary of Statement 52 (commonly referred to as FAS 52).  

To gain a stronger understanding of the principles associated with currency translation, you can refer to the International Financial Reporting Standards (IFRS), International Accounting Standards (IAS) 21.

Understanding the “accounting” relationship between FX gains and losses and CTA

It is important to note here that CTA is not synonymous with foreign exchange (FX) gains and losses, even though they are related. The difference is that FX gains and losses are a transactional exposure while a CTA represents a translational exposure. 

An FX gain or loss happens when there is a change in the FX rate after an invoice is issued and before it is paid. These transactions are recorded in the income statement as they occur, but may be consolidated at a later date, and are transactional in nature. They arise as a result of foreign currency transactions, which occur at the spot exchange rate. As its name suggests, the spot exchange rate is the exchange rate—a specific amount that one currency will trade for in another currency—at a specific moment in time. 

For example, in a given fiscal year, you might hold $100,000 worth of pounds sterling (GBP) and you have to consolidate that into your income statement. Let’s also assume you haven’t added to or subtracted from it during the fiscal year. Due to the spot exchange rate, it is now worth $110,000. The $10,000 difference would be recorded as an FX gain. However, if it were $90,000, then the $10,000 would be seen as an FX loss.

Cumulative translation adjustment is a subset of FX gains and losses. As an accounting term, CTA refers to the cumulative currency translation of all the financial statements of a parent company with foreign subsidiaries. As mentioned earlier, it is recorded as an entry in the equity section of the balance sheet under the line item AOCI—in which gains and/or losses from FX translation have accumulated over a period of years. 

For example, one year, the relative value of the different currencies may be dollar to dollar, the next year it may be $0.90 to a dollar, and the next it may be $1.25 to a dollar. Over time, those currencies can change, and you would need to cumulatively track those changes for that period to check its impact on your financial statements.

While CTA affects the equity section of the balance sheet and does not impact net income directly, FX gains and losses has a direct impact on the income statement and net income.

Understanding and managing FX gain and losses along with recording CTA correctly is crucial for businesses with global operations, subsidiaries, and customers to mitigate the impact of currency fluctuations on consolidated financial statements.

How to calculate and report CTA on your balance sheet

CTA reflects the changes in the value of a company's net assets (that is, assets minus liabilities) that result from fluctuations in exchange rates. These adjustments occur when consolidating the financial statements of foreign subsidiaries into the parent company's financial statements. 

Here are the steps for calculating the CTA for your balance sheet:

Step 1. Identify the assets that were acquired by the subsidiary  in the foreign currency.

Step 2. Translate these assets into the parent company’s functional (primary) currency.

Step 3. Use the CTA formula to calculate the necessary adjustment.

a) Multiply the transaction amount in the foreign currency by the exchange rate on the date the transaction occurred. 

b) Multiply the transaction amount in the foreign currency by the exchange rate on the date the transaction is recorded in the consolidated balance sheet (i.e. when the retained earnings entry is booked). 

c) To get the CTA, subtract the result you got for (a) by the result you got for (b).

‍

Let’s see what this looks like with following example:

A Singaporean subsidiary of a US based company (with USD as the functional currency) sold services in Singapore for SGD 100,000: 

• The exchange rate of SGD 1 is USD 0.96 on the date the transaction occurred.
• The exchange rate of SGD 1 is USD 0.98 on the date the transaction is recorded in the consolidated balance sheet.

Why do you need to calculate CTA for your SaaS business?

Accurately calculating and reporting CTA enables SaaS companies to:

• Account for exchange rate volatility: SaaS companies with foreign subsidiaries and customers are continually exposed to transactions in foreign currencies and any risk exchange rate fluctuations. Cumulative translation adjustments enable finance teams and CFOs to manage the impact of fluctuations in FX rates on financial statements— clearly separating operational performance indicators from those of exchange rates. 
• Enable accurate financial reporting: The CTA is not a result of operational activities (like revenue generation or expenses) but occurs from changes in currency exchange rates affecting the value of net assets. Accounting for currency translations is important during the financial reporting process because foreign currency fluctuations can falsely inflate your business’ profits or losses.
• Maintain regulatory compliance: All the standard accounting principles, including US GAAP and IFRA, insist on the CTA entry to ensure transparency and comparability in financial reporting. 
• Manage investor/stakeholder relations: Accurate CTA entries enhance the transparency and integrity of financial reporting, providing investors and other stakeholders with a clearer picture of the business’ financial health and performance and enabling informed decision-making.

Using technology to improve and enhance your financial reporting processes

To continue to stay ahead in the competitive market, businesses need to consider using strategic finance software to automate their data consolidation and financial reporting processes. 

Using the right SaaS financial reporting software will not only automate your financial reporting processes for your business needs and help you report your foreign exchange transactions more accurately, but also enhance the integrity of your financial statements. 

Drivetrain is a comprehensive, third-generation FP&A software that consolidates all your financial data from across departments, spreadsheets, tools, regions, etc. into a single source of truth. Drivetrain has over 200 integrations, which means that you have ready access to all the consolidated and accurate data and you can slice and dice it per your requirements, in real time, generating data-driven insights and eliminating manual processes and errors.

Explore how Drivetrain can be the best FP&A solution for your business.