A translation adjustment is the difference that appears when the accounts of a foreign entity are converted into the group's presentation currency, and it is recognised directly in equity rather than in profit. It sits in a dedicated line of consolidated equity, usually named the translation reserve or cumulative translation adjustment.
It arises mechanically from the rates used in currency translation. Balance sheet items are converted at the closing rate, income statement items at the average rate for the period, and equity at historical rates. Three different rates applied to a set of accounts that balanced in local currency produce a set that no longer balances, and the residual is the translation adjustment.
It bypasses profit for a substantive reason, not a technical one. The value of a foreign subsidiary expressed in euros varies with the exchange rate, but the group has neither gained nor lost anything as long as it holds the entity. Running that variation through profit would make consolidated earnings swing with currency markets rather than with operations. It therefore accumulates in equity, close after close.
The reserve is recycled only on disposal. When the group sells the foreign entity, the accumulated translation adjustment attached to it is reclassified from equity into profit, where it forms part of the gain or loss on disposal. A reserve built over fifteen years can hit the income statement in a single period.
It should not be confused with an FX gain or loss, which comes from transactions and passes through profit immediately. The two coexist in any multi-currency group, and telling them apart starts with correctly identifying each entity's functional currency.
