A type of reserve that is created to account for foreign currency translation (currency translation). Such a translation involves the conversion of the financial results (financial statements) of a parent company‘s foreign subsidiaries into its functional currency (also known as presentation currency or primary currency).

This reserve captures any exchange differences that arise (at the time of consolidation of the financials of the parent and subsidiary) on a monetary item that is part of a parent’s net investment in a “non-integral foreign operation“. Such translation (or exchange) differences accumulate in a foreign currency translation reserve in the parent’s financial statements until the net investment is completely derecognized, and the differences are to be recognized as income or as expenses, depending on sign (+, -).

In practice, an entity has to initially translate foreign currency transactions in its functional currency using the rate prevailing at the time of consolidation (i.e., the spot exchange rate).