1

Measuring Accounting Exposure

Chapter 9

2

PART I. ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE

I. ALTERNATIVE MEASURESA. TYPES

1. Accounting Exposure:when reporting and

consolidating financial statements requires conversion from foreign to local

currency.2. Transaction Exposure:

occurs from changes in value offoreign currency contracts from

exchange rate changes.

3

ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE

3. Operating Exposurearises because exchange

ratechanges alter the value of future revenues and costs.

4. Economic Exposure= Transaction + Operating

Exposures

4

ALTERNATIVE CURRENCY TRANSLATION METHODS

I. FOUR METHODS OF TRANSLATIONA. Current/Noncurrent Method1. Current accounts use current

exchange rate for conversion.2. Income statement accounts use average exchange rate for the

period.3. Noncurrent assets and liabilities at

historical exchange rates.

5

ALTERNATIVE CURRENCY TRANSLATION METHODS

B. Monetary/Nonmonetary Method1. Monetary accounts use

currentrate

2. Pertains to- cash- accounts receivable- accounts payable- long term debt

6

ALTERNATIVE CURRENCY TRANSLATION METHODS3. Nonmonetary accounts

- use historical rates- Pertains to

inventoryfixed assetslong term investments

4. Income statement accounts - use average exchange

rate for the period.

7

ALTERNATIVE CURRENCY TRANSLATION METHODS

C. Temporal Method1. Similar to monetary/nonmonetary

method.2. Current method can be used for

inventory shown at market value.

D. Current Rate Methodall statements use current exchange

ratefor conversions.

8

PART III.STATEMENT OF FINANCIAL

ACCOUNTING STANDARDS NO. 8I. FASB NO. 8

A. Temporal method utilizedB. Translation gains or losses

1. Reported on income statement

2. Result: net income greatly affected by exchange

rate volatility.

9

PART IV.STATEMENT OF FINANCIAL

ACCOUNTING STANDARDS NO. 52I. FASB NO. 52

A. Dissatisfaction with FASB No. 8true profitability often disguised byexchange rate volatility.

B. Balance sheet translation uses current

rate method.C. Income statement uses

1. Weighted average rate during period or

2. Use rate in effect when revenue and expenses incurred.

10

STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52

D. Translation Gains or Losses

1. Recorded in separate

equity account on

balance sheet.2. Known as cumulative

translation adjustment account.

11

STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52

E. New Distinction under FASB No. 52:functional v. reporting currency

1. Functional currency for foreign subsidiary:

the currency used in the primary economic environment in which it operates.

2. Reporting currency the currency the parent firm uses to prepare its financial statements.

12

PART V.TRANSACTION EXPOSUREI. WHEN DOES IT OCCUR?

A. From the time of agreement to time of

payment.B. Arises from possibility of exchange rate

gains and losses from the transaction.

13

TRANSACTION EXPOSURE

II. MEASUREMENTA. Currency by currencyb. Equals the difference between

1. The contractually-fixed invoice amount in a specific currency2. The final payment amount denominated in current

exchange rate for the specific currency.

14

PART VI.ACCOUNTING PRACTICE AND

ECONOMIC REALITY

I. Accounting v. Economic Exposuremeasurement of exchange rate risk indicatesthat a major difference exists.A. Accounting exposure

reflects past decisions of the firm.B. Economic exposure

1. Focuses on future impact of exchange rate changes.2. Not all future cash flows appear on the firm’s balance sheet.

15

ACCOUNTING PRACTICE AND ECONOMIC REALITY

II. Recommendations for International Business ExecutivesA. There is no relationship between Info from historical accounting techniques

and The firm’s actual operating resultsB. Chief executives should

base management decisions on theeconomic effects of exchange rate

change.