Cumulative Translation Adjustment (CTA)

Overview

There are many online articles that explain the meaning and purpose of ‘CTA’ – but in simple terms, it is an adjustment within the Equity section of the Consolidated Balance Sheet to reflect movements in FX Rates over time.

It is not the same as Foreign Exchange Gains and Losses that are booked on an ongoing basis, on individual transactions or in FX revaluation of assets and liabilities.

This article explains, with examples, how the CTA is used in Accountability and the basis of the CTA calculation.

 

Example Scenario

Note that all examples and data presented below such as the FX Rates used – are entirely fictional and created to illustrate how the calculations work. They do not represent the actual exchange rates for the currencies over that period of time.

Let’s say we are a US headquartered company with operations in the US and other countries. When we create consolidated financial statements (Profit & Loss and Balance Sheet) for the group, we usually produce those consolidated financial statements in USD. In this example, our financial year runs from January to December.

We opened an office in Japan in 2021 and the office started trading in December 2021. 

 

Profit & Loss Statements

The monthly Profit & Loss for the 3 months December 2021 to February 2022 – for the Japan office, currency of Japanese Yen (JPY), looked like this in Figure 1 below.

 

Figure 1 – Monthly Profit & Loss in Local Currency

 

Let’s assume there were some major fluctuations in the FX rate between the JPY (our ‘Office Currency’) and USD (our ‘Reporting Currency’) over that 3-month period. The ‘Average’ Exchange Rate and the ‘Current’ Exchange Rate over those 3 months looked like this: 

 

Figure 2 – Consolidated Exchange Rates from December 2021 to February 2022

Click here for details on how Consolidated Exchange Rates are calculated.

 

You can see that the JPY value against the USD changed considerably over that 3-month period. The Average FX Rate diminished from 0.00900 in December down to 0.00700 in February.

 

Now, let’s say we ran a Consolidated Profit & Loss Statement for the Japan Office in USD – using two different exchange rate options.

• Figure 3 below is the USD P&L using the option ‘Consolidated Exchange Rates’ – which applies the ‘Average’ exchange rate each month by converting the JPY local figures shown above, into USD.
• Figure 4 below is the USD P&L using the option ‘Current Exchange Rates’ – which will simply convert the P&L figures from JPY to USD using the current FX rate – assume that is 0.00700.

Figure 3 – Monthly P&L IN USD using Consolidated Exchange Rates from December 2021 to February 2022            

 

Figure 4 – Monthly P&L IN USD using Current Exchange Rate as at February 2022

 

The results are quite different – for example, the profit in December of USD 7,200 (using the Average FX rate prevailing for December of 0.00900) is devalued to USD 5,600 on the report in Figure 4, where we instead used the Current FX rate of 0.00700.

By using the Current FX rate (in Figure 4), it distorts the trading history of the Japan subsidiary whereas the method in Figure 3 – the ‘Consolidated Exchange Rates’ option, using the ‘Average’ FX rates that prevailed for each month is a more accurate picture of the performance of the subsidiary because it eliminates the impact of changes in FX rates over time.

 

Balance Sheets

Our Balance Sheet at February 2022 in the local currency (JPY) looks like Figure 5 below.

 

Figure 5 – Balance Sheet at February 2022 in Local Currency

 

Now, let’s run our Consolidated Balance Sheet as at February 2022 in the reporting currency (USD) using the same two options as we did for the USD Profit & Loss Statements:

• Figure 6 below is the USD Balance Sheet using the option ‘Consolidated Exchange Rates’ – which values the Asset & Liability accounts using the ‘Current’ FX Rate as at the end of February – but values the trading (Retained Earnings and Current year Earnings) for December-February using the ‘Average’ exchange rate each month in converting the JPY local figures into USD. 
• Figure 7 below is the USD Balance Sheet using the option ‘Current Exchange Rates’ – which values the Asset & Liability accounts using the ‘Current’ FX Rate as at the end of February – and also, values the trading (Retained Earnings and Current year Earnings) for December-February using the ‘Current’ exchange rate each month in converting the JPY local figures into USD – assume that is 0.007000.

 

Figure 6 – Balance Sheet as at Feb 2022 in USD using Consolidated Exchange Rates  

 

 Figure 7 – Balance Sheet in USD using Current Exchange Rates

 

Similarities and Differences between the two balance sheets

• The Net Assets are the same on both – because both converted the JPY closing Balances for the Asset & Liability accounts at the Current FX Rate prevailing at the end of Feb – being 0.00700.
• But the Retained Earnings and the Current Year Retained Earnings are different:
  • On Figure 6, YTD they total USD 17,500 (7,200 + 10,300) – which agrees to our total profit for the 3 months on the P&L in Figure 3, where we used the Consolidated FX rates (the rates applicable to each month)
  • On Figure 7, YTD they total USD 15,400 (5,600 + 9,800) – which agrees to our total profit for the 3 months on the P&L in Figure 4, where we used the Current FX Rate (0.007000)
• The Cumulative Translation Adjustment YTD on Figure 6 of -2,100 is not on Figure 7. This is the ‘CTA’ required to make the Balance Sheet remain in balance – because:
  • We converted the Assets & Liabilities on Figure 6 at the using the Current FX Rate prevailing at the end of February.
  • But we calculated the Retained Earnings and Current Year Earnings based on the prevailing Average Exchange rates in each of the months.

 

How did Accountability calculate the CTA in this scenario?

• Step 1 – Calculate the YTD Retained Earnings and Current Year Earnings from the Local Currency Balance sheet (Figure 5): Result is JPY 2,200,000
• Step 2 – Multiply Step 1 by the Current Exchange Rate at the end of the Feb of 0.00700 (Figure 2): Result is USD 15,400
• Step 3 – Calculate the YTD Retained Earnings and Current Year Earnings calculated using the Consolidated Exchange Rates (see Figure 6): Result is USD 17,500

The Cumulative Translation Adjustment result therefore is -2,100 USD (Step 2 minus Step 3). 

 

This adjustment is added to the Consolidated Balance Sheet (Figure 6) and the Balance Sheet is now in balance (Net Assets equals Total Equity).

 

Set-Up and Pre-Requisites

A couple of items are needed to calculate Cumulative Translation Adjustment (CTA). 

Equity Account

Set up a GL account for Cumulative Translation Adjustments and assign the account on the Default GL Posting Accounts page.

Consolidated Exchange Rates

A subscription to Xignite, via Accountability, is required to create and maintain the Consolidated Exchange Rates table. Subscribing to Xignite's daily feed is required in the consolidated rate calculations.