Peeling away financial reporting issues one layer at a time

FAS 52: Adding Apples and Rocks

FAS 52 on foreign currency translation took effect in 1982 after one of those infamous 4 – 3 votes.  Like other accounting rules promulgated by the FASB, it is nonsense, for the sole purpose of helping CEO’s smooth their reported earnings over the past quarter century.  Largely because FAS 52 makes no sense, it is complex in addition to being much appreciated by issuers of financial statements. This has been fortunate for me, because I have made some good money teaching FAS 52 to accounting professionals for the past 15 years.  It usually takes me a full day to explain the ramificaitons of FAS 52 in reasonable detail, but I thought I would make an attempt in this post to point you to the rule in FAS 52 from which all the other nonsense springs.

Let’s start with an example outside of accounting–an example of something you would never do, but bear with me for a moment.

Two attributes of a person are height and age.  Multiple your height in inches by your age in years; for me, the answer is 4,368. Question: what does the resulting number for you say about the difference between me and you?  Answer: absolutely nothing.    The product of height and age is  a number, completely unrelated to any person’s attributes.  The only way to describe numbers calculated in this manner is by the calculation itself–the product of height expressed in inches and age expressed in years.

Now, a similar example, except this time one within the scope of FAS 52.

  • Company A has no subsidiaries and Company B has a wholly-owned subsidiary in the UK that operates independently of the parent.
  • Both companies issue their financial statements in U.S. dollars.
  • Both companies buy land in the UK at a price of GBP1,000.  At the date of the transaction, the exchange rate was GBP1.00:USD2.00.  Therefore, the acquisition cost of the land in the reporting currency (dollars) is USD2,000 for both companies.
  • The exchange rate moves to GBP1.00:USD1.60 by the most recent balance sheet date; and both companies still own their land.

Every Accounting 101 student knows that, barring an impairment charge, Co. A will report the land on its consolidated balance sheet at its historic cost of $2,000.  Co. A will do this forever until it parts with the land.  But, only a FAS 52 nerd will know the rule that Co. B applies.  The land will be reported at $1,600–i.e. historic cost in UK pounds multiplied by the new exchange rate.  Thus, one company reports their land at historic cost (an attribute of the land), and the other company reports the land at an amount that is not only different, but also at a dollar amount that defies description except for the way in which it was calculated.  (What do you get when you add 2 apples and 2 rocks?  Answer: 4 objects.)

Here is a brief list of ramificaitons of this nonsense that passes for an accounting requirement–all because the clear purpose of FAS 52 is to smooth reported earnings:

  • Economic substance, and not legal form, drives the consolidation of domestic subsidiaries, but not foreign subsidiaries.  The amount reported for the land, or any other asset or liability, and the changes in any asset or liability will be determined by location of the accounting records on which they are maintained.  (Even most CPAs are shocked to learn this.)
  • If you cannot describe what attribute of an asset a number is supposed to convey (e.g., historic cost, replacement cost, fair value, expected present value of future cash flows), you cannot state that the number results in ‘fair presentation.’  The phrase in the auditors report, ‘fairly presented in accordance with GAAP’ can only mean one thing: the auditor checked to see that you followed the rules of GAAP.  (I pronounce “GAAP” with a silent “P”, like “GAA.”)
  • There is no ‘principle’ in FAS 52, yet no one has FAS 52 on their list of things to change in their quest for ‘principles-based’ accounting.  IAS 21, the International Accounting Standard version of FAS 52 was never a work of art, and it was last revised to become virtually identical to FAS 52.
  • Many numbers on the balance sheet can only be described as random drivel as a result of the application of FAS 52.  Therefore, a balance sheet cannot be a ‘statement of financial position,’  as intended.  Should accounting be about presenting useful numbers to investors and other decision makers, or is it enough that total assets balance out to total equities?  Don’t answer that, because it will only make you as depressed as I am.  As I have pointed out in an earlier post, both the SEC and FASB seem to give lipservice to the asset/liability view of accounting, because FAS 52 is a poster child for the revenue/expense view.

By the way, 4,368 is equal to 78 inches tall multiplied by 56 years old.

That’s information.


  1. Reply Andy August 31, 2007

    Wow, thanks for taking a recent accounting graduate’s blind devotion to FASB pronouncements into a bright light allowing me to see. This is the most beneficial thing I’ve read on accounting in a while. It seems the FASB should not have written their statements of financial concepts, not because they are wrong, because the FASB can’t adhere to them. Thank you for writing frankly and getting my critical thinking juices flowing.

  2. Reply Gerardo Ramirez September 13, 2007

    FAS 52 is very ambiguous. I am currently trying to figure out if the functional currency of our business is the US dollar. Despite being a Central American companies (with subsidiaries in Mexico, South America, the Caribbean) we use the dollar as the main currency and almost all transactions are handled in US Dollars. So I say that our functional currency is the dollar. The auditors however come in and say its not that easy and that I should apply FAS 52. There are some tests in this statement which are supposed to give guidance, but they rather confuse me a lot.
    Does anyone know any site that would provide some guidance as to how to use those confusing economic substance criteria detailed in the statement?

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