5 Best Practices to Avoid Errors in Foreign Currency Transactions
Minneapolis, MN |December 19, 2024 | By: John Trefethen, Director and Co-Founder
Dealing with foreign currency transactions can seem daunting for many organizations. Foreign currency transactions produce interesting challenges for financial professionals and their Enterprise Resource Planning (ERP) systems. While basic currency conversions may seem simple, some transaction types can cause material misstatements in financial reporting and hedge results if not managed appropriately. This article breaks down complex categories of foreign currency transactions and provides detailed best practices for handling them effectively and accurately.
1. Implement Robust Controls Around Foreign Accruals and Credit Memos
Accurate foreign accruals and credit memos are crucial for any organizations managing more than one currency. Since exchange rates are constantly changing, foreign accruals can lead to discrepancies quickly if they are not carefully controlled. Implementing robust internal controls around these areas helps make sure that balances remain correct. This is especially true for quarter-end and year-end reporting.
As you implement these controls, there are few steps that should be completed:
Step 1: Create automated exchange rate updates by integrating a system to export real-time exchange rates directly into your company’s Enterprise Resource Planning (ERP). By adding this first step, accruals and credit memo calculations will stay current, decreasing the risk of outdated rate use.
Step 2: Review foreign accrual policies. Foreign currency accruals should be updated frequently, ideally monthly, to steer clear of big reconciliation adjustments at year-end. As you review, implement transparent policies on when and how foreign currency accruals are updated to keep books correct.
Step 3: Cross-verify credit memos. Confirm all foreign credit memos are referenced against original invoices or accruals for accurate currency, amount, and exchange rates. This step is crucial because any mistakes at this point can spill into revenue and expense accounts, affecting overall net income.
2. Maintain Watchfulness in Stopping Shadow Balances
Shadow balances are a method to monitor fluctuations in a set of financial accounts. They are specifically used when organizations want to track possible scenarios or run side by side records without impacting the primary accounts and can arise when transactions are recorded in one currency but settled in another.
These balances often occur when foreign currency transactions are not correctly reconciled, leading to discrepancies that are hidden in the accounts. The balances that are not accounted for can create large financial statement issues and prevent a clear vision of the organization’s financial position.
To correctly mitigate shadow balances, there are three steps you can take to minimize risk:
Step 1: Track all your currency conversions. Be detailed and thorough when processing any foreign transactions. By doing this, it will help minimize the chance of shadow balances piling up in alternative accounts. Also, be sure to use official exchange rates and document any changes as soon as possible.
Step 2: Perform frequent reconciliations. Once a month, schedule and implement a reconciliation procedure to look for shadow balances and uncover any abnormalities. By doing this, you will shine a light on foreign transactions that have inconsistencies before they become an issue for your organization.
Step 3: Automate account mapping. To minimize the chance of a shadow balance, many EP systems have the functionality for automated mapping. Using this tool can help you can ensure all foreign currency totals are correctly tracked in the appropriate accounts.
3. Establish Transparent Procedures for Intercompany Eliminations
Intercompany transactions are financial exchanges between different legal entities within the same parent company. These exchanges occur across borders and involve various currencies. Intercompany transactions could bring errors in foreign currency reporting. This is specifically true when organizations use unique reporting currencies across their subsidiaries. If an organization doesn’t have clear guidelines put in place, these types of transactions may lead to inflated balances, duplication or elimination of balances, and/or incorrect consolidated balances.
Here's how to establish transparent procedures of these transactions:
Step 1: Set up a procedure for intercompany elimination processes. Standardize language by documenting and defining a standard elimination process for intercompany transactions. This process should highlight currency exchange rate application, timing of eliminations, and documentation guidelines.
Step 2: Use consistent exchange rates for eliminations: Make sure all entities use the same exchange rate for intercompany transactions at the point of transaction recording. By doing this, it will limit the number of inconsistencies and make eliminations simpler.
Step 3: Establish and implement automated tools for intercompany elimination. Using ERP system functionality (or other available tools such as FXpert) designed specifically for intercompany netting processes can decrease the risk of human error and simplify the process altogether.
4. Consistent Review and Updates to Processing Procedures
With markets always evolving, it is important for foreign currency transaction processes to continuously be evaluated and optimized. By updating your procedures regularly, it will ensure they are up-to-date, accurate, and following best practices.
Here are three steps that can help:
Step 1: Schedule annual or semiannual reviews of procedures. Create a procedure to review your foreign currency plan at least one or two times a year. By doing this, it will help ensure that all regulatory rules are accurately depicted in your process.
Step 2: Adapt to market changes: Currency volatility can affect transaction costs and financial positions. If your company operates in high-volatility regions, consider adding procedures for more frequent rate adjustments or accrual updates.
Step 3: Align with regulatory requirements. Make sure you are in compliance by checking your procedures against any local or international standards, as they can be different based on the country. Some of these standards include IFRS and GAAP.
5. Invest Time and Money Into Staff Training and System Configuration
Having a successful reporting process is only possible if the team who operates it is up-to-speed. It is important that your team fully understands foreign currency transactions, exchange rates, policy regulations, and the complexity of a transaction.
A few steps to ensure your team is set up for success include…
Step 1: Train your team on currency-specific policies: Your team should be aware of the requirements for all types of transactions and understand the risk surrounding each of them.
Step 2: Utilize ERP system features: Ensure your ERP system supports foreign currency transactions in an optimal fashion. Many systems have tools and aspects to them that are not utilized. Be sure to use tools that show real-time updates, have dedicated foreign gain/loss accounts, etc.
Step 3: Continue your team’s education. The financial industry is ever-changing, so continuing education is the best way for your team to stay up to date on relevant events. Some examples of trainings include certifications, webinars, and workshops.
Conclusion
Proper management of foreign currency transactions requires a full understanding of many complex scenarios and how they could impact your financial statements. By following the steps laid out in this article ahead of time, and handling these areas systematically, organizations can guarantee greater accuracy and transparency in financial reporting, in addition to having more effective hedge programs.
Need help with your foreign currency transactions? The team at HedgeStar is here for you. Get in touch today to see how we can help.
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Author: John Trefethen, Director and Co-Founder
Mobile: 612-868-6013
Office: 952-746-6040
Email: jtrefethen@hedgestar.com
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