management of translation exposure
TRANSCRIPT
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Management of
Translation Exposure
Chapter Objective:
This chapter discusses the impact that unanticipatedchanges in exchange rates may have on theconsolidated financial statements of the multinationalcompany.
Chapter Outline Translation Methods
Management of Translation Exposure
14Chapter Fourteen
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Translation Exposure
Translation exposure, (also called accounting exposure), resultsfrom the need to restate foreign subsidiaries financial
statements, usually stated in foreign currency, into the parentsreporting currency when preparing the consolidated financialstatements.
Restating financial statements may lead to changes in theparents net worth or net income.
Two methods Current rate method
Temporal Approach
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The Current Rate Method
Advantages of CTA
Eliminates the variability of net earnings due to translation
gains or losses.
The relative proportions of individual balance sheet
accounts remain the same (debt-to-equity ratio, for
example).
Main disadvantage of CTA
violates the accounting principle of carrying balance sheet
accounts at historical cost.
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The Current Rate Method: An Example
Foreign Subsidiary, Inc., (FSI) has been acquired onDecember 31, 2000 when the exchange rate was LC1.25/$
(LC stands for FSIs local currency). On December 31, 2001, the exchange rate was LC1.15/$.
The average exchange rate during 2001 was LC1.18/$.
On December 31, 2002, the exchange rate was LC1.22/$.The average exchange rate during 2002 was LC1.20/$.
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The Current Rate Method: An Example
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The Current Rate Method: An Example
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The Current Rate Method: An Example
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The Current Rate Method: An Example
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The Current Rate Method: An Example
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The Current Rate Method: An Example
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Temporal Method
Monetary assets (cash, marketable securities, AR) and monetary
liabilities (current liabilities and LTD) are translated at the current ER
(exchange rate at the balance sheet date). Non-monetary assets (inventory, fixed assets, etc.) and non-monetary
liabilities are translated at their historical rate.
Income statement items are translated at the average ER over the
period, except for items that are associated with non-monetary assets or
liabilities, such as COGS (inventory) and depreciation (fixed assets),which are translated at their historical rate.
Dividends paid are translated at the rate in effect on the payment date.
Equity items are translated at their historical rate, and include any
imbalance.
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Temporal Method
Logic behind differentiating monetary and non-monetaryassets:
Translation gains and losses on monetary accounts arepresumed meaningful components of expenses or revenue
because monetary accounts closely approximate marketvalues.
Translation gains and losses on non-monetary accounts are
less meaningful since non-monetary accounts reflecthistorical costs.
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Temporal Method
Gains and losses resulting from translation are carrieddirectly to current consolidated income
Unlike the current rate method these gains and losses do notgo to an equity reserve account.
FX gains and losses introduce volatility of consolidatedearnings.
This volatility is damped to the extent that many items in thetemporal approach are translated at their historical costs.
The main advantage of this method is that it complies withthe accounting principle of carrying balance sheet accountsat historical cost.
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The Temporal Method: An Example
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The Temporal Method: An Example
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The Temporal Method: An Example
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The Temporal Method: An Example
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The Temporal Method: An Example
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Translation Exposure versus
Transaction Exposure Translation Exposure
The effect that unanticipated changes in exchange rates
has on the firms consolidated financial statements. An accounting issue.
Transaction Exposure The effect that unanticipated changes in exchange rates
has on the firms cash flows. A finance issue
It is generally not possible to eliminate bothtranslation exposure and transaction exposure.