For financial reporting reasons, if the firm has ownership over a foreign subsidiary, then the foreign subsidiary must be integrated into the US ownership. It is the company’s responsibility to combine the company’s financial data at the conclusion of each reporting period. Since the parent firm is based in the United States, the parent’s operational currency, or the primary currency in which a corporation trades, is the US dollar. Furthermore, the company has to establish that the reporting currency, or the currency in which the accounting records will be presented, is the US dollar. The functional currency of the foreign subsidiary is the local currency, but because the reporting currency is the US dollar, the firm must exchange the foreign accounting records into US dollars at the conclusion of the fiscal quarter.
This phenomenon, known as the translation adjustment, is recorded in the account of other income statements, with the combined impact reflected in equity as other retained earnings. Unfortunately, the translation adjustment has no effect on net profit. To effectively create the cash flow report, one must prepare a separate financial statement in the local currencies of each firm, translate them to the reporting currency (by using relevant exchange rates), and aggregate them.
Currency swings are an unavoidable result of flexible exchange rates, which are usual practices in the majority of large economies. Exchange rates are influenced by a variety of variables, including a country’s financial performance, inflation expectations, monetary policies, foreign investment, and other events. The soundness or instability of the economic activity level often determines the currency exchange rate. As a result, the value of a currency might change from one period to another. As a rule, if the US dollar exchange rate falls in relation to the foreign currency, the value of the foreign direct investment rises; it also works vice versa. If the worth of the foreign currency increases in relation to the US dollar, but the production cost in this country remains constant, the cost of manufacturing for the US business (expressed in the US dollar) rises. Production, service quality, marketing, taxation, and legal fees also impact the expenses and income. Thus, exchange rate changes can directly influence Global Design’s daily financial operations, with rising value as an adverse factor.
Establishing a foreign subsidiary is a decision that must be made based on the company’s current situation and future goals. If the company’s staff is dispersed globally, establishing local subsidiaries makes no logical sense. However, having several remote employees in the same area could be worth the investment. Having a permanent workforce accessible from the beginning guarantees that the subsidiary company might become operative much faster. The other advantage is the fact that the subsidiary is an independent component of the parent firm; the corporation has less risk throughout its worldwide development. If a subsidiary gets prosecuted or breaches legislation, only the subsidiary bears responsibility or pays the penalties. Meanwhile, the parent firm has minimal accountability and is shielded from the repercussions of a subsidiary’s actions. Finally, creating a foreign subsidiary also enables the successful exploitation of tax breaks and incentives, such as lower taxation than in the domestic country. Whatever the company’s reasons to open the local subsidiary are, one should consider the risk and investigate and examine potential expenses and documentation. The alternative plan can be to build a branch office.