Translation exposure
What?
Risk that a company's equities, assets, liabilities in the b/s & i/s will change due to foreign exchange rate changes
Eg: firm accumulates assets & liabilities overseas in foreign currencies but need to translate in its b/s into home currency
Current/non current method
Monetary/non monetary method
Temporal method
Current/ closing rate method
Foreign subsidiaries' current assets & liabilities are translated into home currency at current FX spot rate
non-current assets & liabilities converted at historical FX rate
I/s translated at average FX spot rate over that period except for non-current assets (depreciation) converted at asset's historical rate
Monetary accounts use current FX rate. Include:
Cash
Accounts receivable
Accounts payable
Long Term debt
Non-monetary accounts use historical FX rates. Include
Inventory
Fixed assets
Long term investments
Income statements use average spot exchange rate over that period but convert non monetary expenses (depreciation) at historical rate
Similar to monetary/nonmonetary approach
Difference: uses current method in for inventory
Inventory is converted at current FX rate & reflected in b/s
Simplest approach, income & b/s assets & liabilities use current FX exchange rate for value conversion
Managing translation exposure
Adjusting amounts & currencies flows between foreign parent & local subsidiaries to reduce firm's local currency accounting exposure
Use forward contracts to offset FX assets/ liability exposures
Netting exposures in one currency with exposures in another and gain/losses will offset each other
Hedging to reduce translation exposure by holding more hard currency (appreciate) assets and decrease hard currency liabilities (vice versa)