What Is Currency Translation in SAP S/4HANA?

Currency translation is a process in which an organization translates the financial data of its foreign subsidiaries from their transaction currency into the group currency of an organization.

This is so that subsidiaries’ financials can be recorded in group financial statements. The foreign subsidiaries still report their financials in their corresponding transaction or local currencies.

Let’s discuss an example to better understand the currency translation process. An organization that operates in multiple countries will have financials in multiple currencies as a result of business operations in different companies. For consolidation purposes, you need to have financials in the organization’s group currency; this is the primary reason you need to perform currency translation. In the scenario that we’re discussing in this chapter, holding company 9001 reports in USD, which is also the group currency for your consolidations and its subsidiary 9006, which reports in GBP for its transaction currency. In this chapter, we’ll discuss how to translate 9006’s reported financial data from GBP to USD to consolidate the financials at the group level.

Currency translation makes it easier to analyze the financials at the group level for the executive team of an organization; otherwise, it would be very hard to analyze the organizational performance in more than one currency.

In the following sections, we’ll introduce key currency translation concepts and functionality in SAP S/4HANA Finance for group reporting.

Currency Translation Basics

Currency translation can be a very complex issue due to various factors. The following are two major factors that may impact the reported financial data:

• Exchange rate fluctuations
• Inflation rates

For example, consider a subsidiary that is in a country whose currency is weak compared to the parent. As you perform currency conversion using year-end rates to convert its assets into group currency, there is a risk of understating the subsidiaries’ asset values as their depreciation might not be proportional with the local currency of the subsidiary. However, due to inflation, the fixed assets of the subsidiary aren’t impacted much because they are worth more in the subsidiaries’ local currency. Typically, these two scenarios offset each other, so there is greater probability that assets of the subsidiary are pretty much stable in parent companies’ books. But this isn’t the same case with the inventories, receivables, and liabilities, as their value is directly proportional to the subsidiaries’ currency, which means irrespective of their maturity, they all depreciate with the local currency. On the other hand, if the subsidiaries’ local currency is stronger than that of the parent, the implications are reversed, but the situation is still the same. Because of this, you need to consider the following points to accurately capture the developments related to the foreign subsidiary:

• What is the impact on the consolidated results due to the translation of the subsidiary’s local currency into the parent company’s group currency?
• What adjustments will arise due to the translation of a subsidiary’s assets?

The answer to these questions comes from using currency translation methods and capturing the translating differences that arise due to these translations. Following are the two most common methods used:

• Closing rate method: This is used when a subsidiary is financially independent of its parent (most common case). In this method, the currency translation differences are recorded under the shareholders’ equity. All assets and liabilities are translated at this rate, which is essentially the rate of exchange at the balance sheet date. Revenues and expenses are translated using the average rate, which is the average exchange rate for the period.
• Temporal rate method: This is used when a subsidiary isn’t financially independent of its parent. In this method, the difference between the net income on the balance sheet and the net income on the income statement is recorded on the income statement as foreign exchange gains and losses. The following rates are relevant:
  • Closing rate: Monetary items such as cash, receivables, and payables are converted into group currency using the closing rate.
  • Historical rate: Nonmonetary items such as fixed assets, depreciation, amortization, goodwill, inventories, prepayments, and shareholders’ equity are converted using the historical rates.
  • Average rate: Income and expenses are converted.

Now let’s discuss currency translation adjustment (CTA). CTA is an entry that is recorded in the balance sheet in the Accumulated Other Comprehensive Income section. This helps you analyze the gains and losses that result from dynamic exchange rates. This entry helps investors of an organization understand actual operating gains and losses versus the gains and losses generated by currency conversion. Organizations with foreign subsidiaries make sure that CTAs are an integral part of their financial statements. The CTA balance accumulated over the years is recorded in the accumulated other comprehensive income, which is a component of equity.

Let’s consider an example. In this scenario, 9001 invested USD $100 million in the foreign subsidiary 9006 (with GBP as its reporting currency). Let’s assume that this investment has appreciated to USD $110 million due to the foreign exchange, so you need to understand how to record this unrealized gain of USD $10 million.

The following is the journal entry that you would post to record the gains due to foreign exchange fluctuations:

• Debit: Investment (increase in foreign assets) USD $10 M
• Credit: CTA account USD $10 M

When you liquidate 9006, you would record the transactions as follows:

• Debit: CTA account USD $10 M
• Credit: Income statement USD $10 M

Let’s discuss a practical example of currency conversion and booking CTA. The table below shows the retained earnings of your foreign subsidiary 9006 at the beginning of fiscal year 2023, which is translated from local currency to group currency by historical rates. It also shows the net income at the end of fiscal year 2023, which has been translated using the average method and has been rolled forward to the retained earnings. Finally, you have year-end values for retained earnings, which are recorded in 9006’s balance sheet.

Now that the retained earnings are calculated at the fiscal year 2023 year end, the balance sheet of 9006 will be carried forward to fiscal year 2024. The next table shows the trial balance of 9006 pre-currency conversion and post-currency conversion and the calculation of CTA. It describes the trial balance of 9006 in GBP and how each balance sheet item and profit and loss (P&L) statement is calculated. Balance sheet items such as cash, accounts receivable, inventory, plant and equipment, accounts payable, and long-term debt are translated using closing or end rates, whereas other balance sheet items such as common stock are translated based on historical rates.

Retained earnings have been carried forward from the prior year as is, whereas income statement items such as sales, COGS, depreciation expenses, and other expenses are calculated per average rates, and dividends declared are recorded per the exchange rate when they were declared.

After the entire trial balance is converted to group currency, which is USD, you aggregate the values to derive the CTA, which is presented in the Accumulated Other Comprehensive Income section of the company’s translated balance sheet. As you can see in this example, the CTA of 9006 in USD after conversion gives you a picture of gains and losses that happened due to foreign currency exchange rate fluctuations over fiscal periods. Recording CTA separately helps you identify actual operational gains and losses versus gains and losses that result from currency exchange gains and losses.

Currency Translation in SAP S/4HANA

Currency translation is done in the corporate close process using SAP S/4HANA Finance for group reporting. It’s very common for an organization to have multiple subsidiaries in other countries that report in their local currencies at month end when the corporation is consolidating its financials. The company consumes the subsidiaries’ financials in local currency, translates them into group currency, and finally uses the values in the group currency to generate group financial statements during the period close.

Following are some key terms that you need to know to understand the currency translation process in SAP S/4HANA Finance for group reporting:

• Exchange rates: Exchange rates are maintained in SAP S/4HANA Finance for group reporting to perform currency translation (e.g., period average rates or monthly rates).
• Posting level: 0T is the posting level for standardized and consolidated data, which is used in rounding from currency translation.
• Methods: Following are the predefined methods in SAP S/4HANA Finance for group reporting:
  • Y0901: Standard method in group reporting for YTD values.
  • Y0902: Keep group currency values from SAP S/4HANA (table ACDOCA) and balance sheet retranslate at the closing rate.
  • S0901, S0902: Methods can be both YTD as well as periodic, but they are also dependent on the period of acquisition.
  • S0903: Standard method for periodic values that you generally use for income statement values.
• Selection object: In the currency translation method, you use this indicator to specify how you determine the source data region, such as opening balance of current asset accounts. If you select Selection Object, it allows for the use of a previously defined selection object; if you didn’t select it, then the source data region becomes method specific.
• Financial statement (FS) items: While defining the FS items, you can select currency translation and define conditions in the Define FS Items app.
• Measures: You can define reports with specific measures, which can be defined with one of the following values:
  • Local Currency (LC)
  • Group Currency (GC)
  • Transaction Currency (TC)
• Currency fields: Currency fields in both table ACDOCA and table ACDOCU are used to hold details about the currency values. Currency fields in table ACDOCA are as follows:
  • WSL: Transaction currency.
  • HSL: Local currency.
  • KSL: Group currency amount.
  • TSL: Transaction currency (documents that are posted in period 000).

Currency fields used in table ACDOCU are as follows:

• WSL: Forms a union between the WSL field in the Universal Journal and the TSL field in the consolidation journal.
• HSL and KSL: Uses ledger-dependent data sender currency fields of the consolidation unit to decide which amount fields are read from the Universal Journal as local currency and group currency.

Editor’s note: This post has been adapted from a section of the book Group Reporting with SAP S/4HANA: The Financial Consolidation Guide by Eric Ryan, Thiagu Bala, Satyendra Raghav, Azharuddin Mohammed, and Sumit Kukreja.