Accounting in the local currency may lead to significant, unrealized exchange rate differences in the financial statements. Should this lead to a loss, it may be necessary to recapitalize the equity, while in the case of exchange rate gains, although no real profits have been made, corporate tax liability may be higher. Divergences between local and foreign settlements due to exchange rate differences are also common.
Below we summarize the aspects on the basis of which it is worthwhile for international companies to use a different currency for their foreign subsidiaries as accounting currency, such as EUR, GBP or USD, as opposed to the local currency. In our description we will use Hungary as an example.
Most international companies typically perform their business processes in Euro (€ or EUR), US dollars (US$ or USD) and Sterling (£ or GBP) or other foreign currencies. In the case of accounting in the local currency, such as HUF, these processes are recorded using sometimes extremely volatile exchange rates. At the end of the business year the valuation of assets and liabilities in HUF is mandatory. The above -mentioned, repeatedly registered exchange rate differences may lead to significant so-called unrealized foreign exchange losses or gains.
Unwanted exchange rate fluctuations leave a mark in the financial statements even if they are not reflected in factual financial processes. In practice, foreign exchange risks can be eliminated in many cases in the course of the financial settlement of accounts. For example, payments are often made from bank accounts kept in the same currency (e.g. a EUR, USD, CHF) as the transaction currency, so that no financial exchange rate loss will be realized (‘natural hedging’). Additional exchange rate risks may be reduced using specific financial instruments such as foreign exchange spots or futures.
Nevertheless, even if there is no factual exchange rate gain or loss, or it is not significant, the occurrence of unrealized exchange rate gains or losses in the forint-based accounting cannot be avoided. This is because the exchange rates associated with a given transaction are recalculated more than once in accordance with the accounting rules.
The problem of exchange rate differences persists even if a company has most of its revenues and expenditures in the same currency, e.g. in Euros. This is due to the fact that Euro revenues and expenses may correspond to different forint amounts during the year, and the year-end revaluation of foreign currency assets and liabilities may cause additional distortions in the income statements.
Unrealized foreign exchange gains and losses also affect the corporate tax base. This can have a significant impact, especially on longer-term, higher-value financial assets and long-term liabilities.
In order to eliminate the above unfavorable effects, the Corporate Tax Act provides for the possibility of tax base adjustments. Accordingly, no tax is payable on long-term financial assets and liabilities due to unrealized foreign exchange gains or losses as long as these items are included in the books. When these financial assets and liabilities are written off, including impairment losses, foreign exchange gains or losses will be recognized for corporate income tax purposes on an ultimate basis.
The application of corporate tax base adjustments is voluntary. However, if the entity has exercised this option, it shall apply the adjustments to all non-current financial assets and long-term liabilities. This decision cannot be made at a later date and there is no possibility of self-revision. At the same time, the corporate tax base adjustment option is not a solution to neutralize the often significant unrealized foreign exchange gains or losses arising from settlements with suppliers and customers.
Accounting in HUF may cause discrepancies between accounting data recorded in EUR, USD or other foreign currencies by the foreign parent company and the data converted from HUF in Hungary. Discrepancies in areas such as reporting, controlling, logistics, warehousing and account consolidation can lead to additional work and difficulties in communication for the staff that manages the different systems.
Taking into account the above aspects, if the extent of unrealized exchange rate differences and other adverse factors arising from accounting in HUF are significant, the management of the company may make a decision to switch to accounting in EUR, USD or another currency. If a company has several functional currencies, it is worth examining their magnitude and exchange rate fluctuations.
The subsidiary can decide on using a different accounting currency already at the time of incorporation. In the case of the establishment of a limited company (Kft. or Ltd.) the subscribed capital may be stated in the articles of association in Euros or US dollars only if the accounts are kept in the same currency. In all other cases the share capital of the Ltd. must be specified in HUF in the articles of association.
The decision to account in Euros or US dollars should be carefully considered because if the company has decided to do so, the decision cannot be changed for the next 3 years.
As for other currencies, such as GBP or Swiss francs (CHF), companies can choose to account in those currencies no sooner than the second year of operation. It is also a condition that the currency concerned (other than the Euro or the US dollar) is the currency of the firm’s primary economic environment (functional currency) and that more than 25% of
(a) revenues and expenses; and
(b) financial assets and financial liabilities
in both the previous and the current business year arise the given currency (e.g. GBP or CHF).
If a company already operating wishes to switch to accounting in a foreign currency, this is possible at the end of the business year, i.e. at the balance sheet date, accompanied by an amendment of the accounting policy and the articles of association.
The transition process from accounting in Hungarian forint to EUR or USD entails several complex tasks and for a successful and verifiable result it is worth working with a to-do list containing also deadlines. The changeover and the accounting in foreign currency require special expertise on the part of the employees involved and the accounting software must also be suitable for performing the additional functions.
During the changeover a balance sheet must be prepared in each HUF and the chosen currency followed by the opening of the books on the day after the changeover. The conversion takes place on the basis of the approved financial statements and general ledger, using the official exchange rate of the Hungarian National Bank MNB. Revaluation must also be performed at the analytical level. The opening balance sheet prepared on the basis of the above must be certified by a financial auditor, however without the obligation of disclosure.
Following the changeover, assets and liabilities denominated in HUF and other currencies must be converted into EUR and USD using the chosen exchange rate (typically the official MNB exchange rate). Liabilities in HUF include wages and related taxes and contributions, as well as tax liabilities. VAT deserves special attention, as the amount of VAT must also be determined and accounted for in HUF in the case of invoices issued in other currencies, based on the specific rules applicable.
At the end of the business year assets and liabilities in foreign currencies including the forint (i.e. not denominated in EUR or USD) are valued. Cash , bank account balances as well as outstanding receivables, financial assets, securities and liabilities must be valued at the relevant exchange rate valid on the balance sheet date of the business year in the relevant accounting currency, i.e. EUR or USD.
It can be stated that accounting in foreign currencies is more complicated and requires more effort than accounting in HUF. However, the optimal management of exchange rate gains and losses, as well as simpler and more transparent administrative processes within the group, now directly on a EUR or USD basis, entail many benefits and can also result in financial savings.
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