The Impact of the Functional Currency System in Korea on the Value Relevance of Foreign Translation Adjustments

Meenseok Khil ; Jung Min Park ; Ingoo Han

(First Author) Adena Software khilmeenseok@gmail.com
(Corresponding Author) Kookmin University paspark1@gmail.com
(Co-Author) KAIST College of Business ighan@kaist.ac.kr

Copyright 2011 THE KOREAN ACADEMIC SOCIETY OF BUSINESS ADMINISTRATION
This is an open access article distributed under the terms of the Creative Commons Attribution License 4.0, which permits unrestricted, distribution, and reproduction in any medium, provided the original work is properly cited.

Abstract

This study examines whether the introduction of a functional currency system improves the value relevance of foreign translation adjustments in Korea. Companies' incomes and equities have been exposed too heavily on the changes of foreign exchange rates when these companies have transactions in foreign currencies or foreign operations. The adoption of the functional currency system is expected to minimize unexpected foreign translation adjustments from the fluctuation in foreign exchange rates and then improve the value relevance of foreign translation adjustments. We select Korean transportation and manufacturing companies which are usually highly affected by foreign currency exchange rates as a study sample. Using a return/earnings association approach, we find that the adoption of the functional currency system improves the value relevance of foreign translation adjustments for firms that designate foreign currency as a functional currency. After the adoption of the functional currency system, we do not find an incremental effect on the value relevance of foreign translation adjustments for firms that choose a local currency as a functional currency. However, for firms that choose foreign currency as a functional currency, an excessive effect from foreign exchange rates is alleviated thereby improving the value relevance of foreign translation adjustments.

Keywords:

Functional currency, Foreign translation adjustment, Value relevance

References

Bartov, E.(1997), “Foreign Currency Exposure of Multinational Firms: Accounting Measures and Market Valuation,” Contemporary Accounting Research, 14(4), pp.623-652. [https://doi.org/10.1111/j.1911-3846.1997.tb00544.x]
Collins, D. W., and W. K. Salatka(1993), “Noisy Accounting Earnings Signals and Earnings Response Coefficients: The Case of Foreign Currency Accounting,” Contemporary Accounting Research, 10(1), pp.119-159. [https://doi.org/10.1111/j.1911-3846.1993.tb00385.x]
Huang, A., and S. Vlady(2012), “The Accounting and Economic Effects of Currency Translation Standards: AASB 1012 vs. AASB 121,” Journal of Modern Accounting and Auditing, 8(11), pp.1601-1610.
Kwon, S.(2009), “Revision of Accounting Standards Related to Foreign Currency Translation,” Korea Accounting Institute, Available at http://www.kasb.or.kr, .
Louis, H.(2003), “The Value Relevance of the Foreign Translation Adjustment,” The Accounting Review, 78(4), pp.1027-1047. [https://doi.org/10.2308/accr.2003.78.4.1027]
Park, K. H., S. Y. Lim, C. B. Kim, and C. W. Lee (2009), “The Effect of Functional Currency and Foreign Currency Translation of K-IFRS: A Case Study of D Company in the Marine Transportation Business,” Korean Accounting Journal, 18(1), pp.87-112.
Pinto, J. A.(2005), “How Comprehensive is Comprehensive Income? The Value Relevance of Foreign Currency Translation Adjustments,” Journal of International Financial Management & Accounting, 16(2), pp.97-122. [https://doi.org/10.1111/j.1467-646X.2005.00113.x]
Soo, B. S., and L. G. Soo(1994), “Accounting for the Multinational Firm: Is the Translation Process Valued by the Stock Market?,” Accounting Review, 69(4), pp.617-637.

∙ The author Meenseok Khil is graduated from Seoul National University and received MS in management engineering from KAIST. She worked as a management consultant at Samil PwC and Samjong KPMG, and is currently working at Adena Software. Her main interests are accounting system and valuation.

∙ The author Jung Min Park is currently a lecturer in the Department of Finance and Accounting at Kookmin University. After graduating from Sogang University, she received her MS and Ph.D from KAIST in management engineering. Her main areas of interest are accounting systems, earnings management, and valuation.

∙ The author Ingoo Han is a professor at KAIST College of Business. He majored in international economics at Seoul National University, received MS in management science from KAIST, and Ph.D. in accounting information systems from University of Illinois at Urbana-Champaign. His research interests include financial analysis using artificial intelligence, credit rating system, and valuation. He has published over 150 papers in domestic and international journals. He served as the editor-in-chief of the Korea Management Review, the president of Korean Academic Society of Business Administration, and the president of Korea Society of Management Information System.