Costly currency surprises and their negative effects are self-inflicted wounds. Companies instituting multicurrency accounting best practices to get accurate, complete, and timely exposure data can minimize injury from these preventable problems. What are the issues preventing treasury from getting accurate, complete, and timely exposure data?

Remeasurement inconsistencies. For one, different groups within the company may have inconsistent practices for remeasurement of accounts. Some entities may remeasure prepaid expenses, while others do not. Some may remeasure all cash accounts, while others remeasure only some. These types of inconsistencies create "noise" that clouds the treasurer's visibility into the organization's true exposures, making it difficult or impossible to effectively manage risk to the desired levels.

For example, imagine that the European entity of a U.S.-reporting company has accounts receivable (A/R) in pounds sterling. Specifically, the company has three A/R line items in GBP. At the end of the month, two of those A/R line items are properly remeasured by accounting, but one is not. When the treasury team gets its exposure report, it sees a GBP/EUR exposure for GBP1,050,000—the sum of the two A/R line items that are being remeasured. The third A/R line item, which is not being remeasured as it should be, is invisible to the treasurer.

Based on the exposure data that treasury gets from accounting, treasury makes the decision to hedge the company's GBP1,050,000 GBP/EUR exposure. Assuming that the hedge completely covers the GBP1,050,000 GBP/EUR exposure, treasury expects to see no currency gain or loss. But in reality, because accounting has not applied the same remeasurement rules to all three A/R line items, treasury does not have visibility into the third A/R balance, which generates an exposure of GBP3,000,000. So in hedging only the GBP1,050,000 exposure, treasury is actually under-hedged. When the third A/R is cleared the following month, the company realizes a EUR156,900 FX loss that it did not expect.

Decentralization-related inconsistencies. Inconsistent remeasurement practices often arise when accounting processes are decentralized. Decentralization does not, de facto, mean that practices will be inconsistent, but when processes are decentralized, consistency and control are much more difficult to achieve. In particular, the following aspects of decentralization often lead to inconsistent remeasurement practices:

• Understanding of the ASC 830 Foreign Currency Translation (FAS52) regulations often varies across geographies, leading to regionally disparate remeasurement processes.
• Even where the types of accounts used are consistent across entities, the use of those accounts is not always consistent. Depending on its business needs, a given legal entity may use only a few accounts at its disposal. This is especially common with cash accounts. Sometimes an entity dumps unbalanced and unmatched transactions into "other" accounts.
• In many cases, an entity is not well-versed in the types of accounts available and their best use, so it simply copies the practices of other entities, even when their business needs differ.

Transaction currency/local currency inconsistencies. In addition to the self-inflicted wounds caused by inconsistent practices for remeasurement of accounts, there are transaction currency/local currency (TC/LC) issues that arise from individuals or entities improperly posting and/or clearing transactions. Improper TC/LC practices include, for example, clearing local-currency balances but not clearing transaction-currency balances, back-dating transactions, and inconsistent rate conventions. Sometimes the improper TC/LC posting and/or clearing stems from a lack of controls or enterprisewide best practices. Other times, it is a mistake or the result of an individual error.

Take the same European entity of a U.S.-reporting company from the previous example. Suppose that on June 5, the euro entity signs a contract with a British company to sell GBP1 million worth of product. That transaction is entered in pounds sterling as a GBP1 million receivable. The enterprise resource planning (ERP) system uses the system rate to calculate the euro equivalent, the entity's functional currency. The euro entity now has a GBP1 million exposure.

The British company pays the receivable on July 10. Now accounting should clear the pound-sterling balance, remeasure it into euros at the current market exchange rate, send today's fair value to the income statement as revenue, and record the difference between today's fair value and the value at the time of posting as an FX gain or loss. (If the entity hedged the full GBP1 million exposure, the FX gain/loss will be offset to zero by the hedge.) If all these steps occurred without a hitch, the underlying economics of the transaction would be accurately reflected.

But what if accounting did not clear the receivable properly, clearing it in the local currency (euros) rather than in the transaction currency (pounds sterling)? The local-currency balance would still get sent to the income statement as revenue, but the original GBP1 million transaction-currency receivable would remain open on the books. Because accounting looks at functional-currency balances translated into U.S. dollars, the A/R balance is zero from the accounting perspective. But from treasury's perspective, the GBP1 million receivable still looks like an exposure that needs to be managed.

When TC/LC issues like this arise, accounting often turns off the account showing the pounds-sterling balance or remeasures the account balance outside of the ERP system. In that case, the TC/LC issue actually creates a remeasurement issue. If the transaction currency account gets remeasured, then an FX gain or loss is created, which impacts the income statement—and the treasurer had no visibility into that exposure or opportunity to manage the resulting risk.

Because remeasurement processes are based upon transaction-currency balances, invalid transaction-currency balances can lead to invalid unrealized FX gain/loss calculations and posted results when remeasurement occurs during period-end processing. Furthermore, the exposure that in reality does not exist (because the receivable has been paid) stays on the books, potentially being remeasured forever.

Lack of cross-entity training. TC/LC problems often arise because of a lack of cross-entity training. Often the person charged with posting transactions has not been properly trained on how multicurrency transactions are supposed to be posted. (Other times, the person simply makes a mistake.) Inconsistent setup of entities within the ERP system can also cause TC/LC problems. For example, we have seen cases where the accounts have not been defined in the same way across all legal entities. Some entities may have the local-currency flag on, while others do not. Some may have the line item display flag turned off; others may not.

Accounting in a complex global company is hard. When multicurrency accounting issues—such as inconsistent practices for remeasurement of accounts and improper posting and clearing of transactions—do arise, they often go undetected by the accounting organization. This compounds the problem. The company's ERP system is built for, and "owned" by, the accounting function, not the treasury group. The focus in accounting is on translating local currency into reporting currency and closing the books.

In our transaction currency/local currency example, where accounting cleared the receivable in local currency rather than transaction currency, the local-currency balance still gets sent to the income statement as revenue. Because accounting looks at local (not transaction) currency balances translated into U.S. dollars, from the accounting perspective the A/R balance is zero.

The treasurer, in contrast, needs to focus on the transaction currency/local currency level. (See Figure 1, below.) To manage currency risk, the treasurer depends on transaction-currency data from the ERP system. When issues at the transaction-currency level lie undetected in the ERP system, it is impossible for the treasurer to calculate exposure accurately and completely.

Because the original transaction-currency receivable from our earlier example remains open on the books, from treasury's perspective it remains an exposure that needs to be managed, even though it has actually been cleared. So if the treasurer's mandate is to hedge exposures as they are defined by accounting, he or she faces a catch-22: He or she is mandated to hedge, but his or her performance will be measured on FX gain/loss results, which will be exacerbated if inaccurate data leads to mis-hedging.

Best Practices in Multicurrency Accounting

Avoiding costly self-inflicted currency wounds, which may arise from inconsistent or improper multicurrency accounting practices that erode data integrity, is largely about institutionalizing best practices in multicurrency accounting. These include:

Accounting does not have to be centralized in order to have uniform processes, but centralization is one way to establish uniformity. Where remeasurement processes are centralized, all entities within the ERP system are remeasuring the same accounts. Accounts are defined consistently across the entities' charts of accounts; each entity uses the same accounts in the same ways, and remeasures the same. That leads to uniformity across entities.

From a best-practices standpoint, accounting should not back-date transactions; transactions should be posted when they are received so that treasury can manage risk at the current-state basis.

Documented process controls are an important tool to avoid both the intentional and the inadvertent errors that often arise in a multicurrency environment. Documented process controls alone can dramatically increase the integrity of the organization's exposure data. Organizations that follow processes and controls, and audit themselves over time, will still see issues, but those issues will not be as chronic.

Ensuring that new entities are set up according to a documented, consistent set of practices is critical for companies that merge with or acquire other organizations. That is certainly the case at Avnet, a Fortune 500 global electronics distributor. As the company's treasurer explains in a FiREapps case study, "We have multiple instances of SAP, and we continuously inherit other ERP systems from companies which we acquire. Many of them need to be quickly integrated into our risk management program so we can understand and mitigate the exposures they bring with them." With the help of the Avnet operational excellence team, treasury established globally consistent exposure risk identification and multicurrency accounting processes that have improved timeliness, accuracy, and controls; enabled cleaner/faster accounting closes; given treasury more time to discuss the qualitative issues surrounding exposure data; and boosted confidence in the FX exposure management program.

Even if the organization has a centralized remeasurement process, if there is a lack of control around setting up new entities, someone has to constantly check to ensure that new entities are being set up appropriately. Best practice here is to have a plan in place that, irrespective of the ERP, defines how to set up a new entity or a new account to make it consistent and applicable across the entire ERP. Best practice organizations ask themselves:

• Is the transaction currency available in the system?
• What kind of process and problems do we run into in getting that data out? Can all users get into the ERP and pull out all the transaction currency information? Are there any settings within the ERP that prevent us from getting that data out?
• Across ERP systems, are all entities set up the same way? All accounts should be defined the same way across all legal entities, meaning create one template for each country and then use it for all entities.

Different functional groups within an organization contribute to the currency risk management process. The FX Gain/Loss line on the corporate income statement is the ultimate product of these efforts. As such, effective currency risk management requires coordination among the contributing functional groups to ensure that the result is both accurate and acceptable within company policies.

The only way to ensure the kind of cross-functional coordination required to properly manage foreign currency risk is to elevate awareness and priority of the issue throughout the enterprise. Acknowledging foreign currency risk management as an enterprise issue means assigning the proper level of oversight, accountability, and resources to the entire process.

A company that institutes consistent training programs and policies across entities is going a long way toward eliminating inconsistencies in FX data. Creating consistent documentation helps to reinforce lessons learned in training. Instituting controls to catch errors is essential as well.

Benefits of Data Integrity

The chief benefit of resolving inconsistent or improper multicurrency accounting practices, which can erode currency-data integrity, is that the treasury team can trust that they indeed have accurate, complete, and timely visibility into the company's exposures. With that visibility, there should be no surprises; treasury can manage currency risk such that any impacts the company does experience will be expected. The company can move from heavy volatility and significant P&L impacts to managed, expected results, and at the same time can reduce transaction costs incurred when treasury is mis-hedging.

Another benefit is reduced risk of compliance issues. As scrutiny of derivatives use by auditors and regulators increases, it becomes even more crucial to ensure that treasury has an accurate, complete, and timely picture of the company's true exposures, to ensure that it is using derivatives in ways that are in compliance with regulations.

Finally, accurate, complete, and timely visibility into currency exposures also allows treasury to be a strategic, value-added partner within the organization. One treasurer, for example, found himself called into contract negotiations because he finally could see how contract decisions would impact the company's currency exposures.

Eliminating FX surprises and reducing the risk of compliance issues can be cost-effective. Tech Data, a Fortune 500 wholesale distributor of technology products, services, and solutions, centralized and standardized currency-hedging practices companywide. Not only did institutionalizing multicurrency accounting best practices significantly enhance the company's FX processes, but overall Tech Data's FX management transformation resulted in EUR1.5 million annual cost savings.

Institutionalizing multicurrency accounting best practices is the first step in a modern currency risk management program. But it is not the last. With best practices in place, the next step is to get accurate, complete, and timely visibility into exposures and then find the optimal level of risk management given the potential cost.

But without data integrity, that's all for naught. You can't manage what you can't measure.

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Wolfgang Koester is the CEO and co-founder of FiREapps, the leader in big data analytics for corporate foreign exchange. For over a decade, the company has helped global leaders eliminate FX surprises, reduce transaction costs and increase operational efficiencies. For more information, go to www.fireapps.com.

For more information on the importance of data integrity in a multicurrency accounting environment, request a complimentary copy of the FiREapps whitepaper, Effective Currency Risk Management Requires Exposure Data You Can Trust Part 1: Setting the Stage – The Importance of Data Integrity in a Multicurrency Accounting Environment.