ManagementofTranslationExposureChapterTenCopyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.ChapterOutlineTranslationMethodsFASBStatement8FASBStatement52InternationalAccountingStandardsManagementofTranslationExposureEmpiricalAnalysisoftheChangefromFASB8toFASB5210-2Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.TranslationExposureTranslationexposure,frequentlyreferredtoasaccountingexposure,referstotheeffectthatanunanticipatedchangeinexchangerateswillhaveontheconsolidatedfinancialreportsofaMNCWhenexchangerateschange,thevalueofaforeignsubsidiary’sassetsandliabilitiesdenominatedinaforeigncurrencychangewhentheyareviewedfromtheperspectiveoftheparentfirm10-3Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.TranslationMethodsFourmethodsofforeigncurrencytranslationhavebeenusedinrecentyears:Current/noncurrentmethodMonetary/nonmonetarymethodTemporalmethodCurrentratemethod10-4Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.Current/NoncurrentMethodTheideathatcurrentassetsandliabilitiesareconvertedatthecurrentexchangeratewhilenoncurrentassetsandliabilitiesaretranslatedatthehistoricalexchangeratesisthecurrent/noncurrentmethodUnderthismethod,aforeignsubsidiarywithcurrentassetsinexcessofcurrentliabilitieswillcauseatranslationgain(loss)ifthelocalcurrencyappreciates(depreciates)ThismethodofforeigncurrencytranslationwasgenerallyacceptedintheUnitedStatesfromthe1930suntil1975,atwhichtimeFASB8becameeffective10-5Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.Monetary/NonmonetaryMethodTheideathatmonetarybalancesheetaccounts(e.g.,accountsreceivable)aretranslatedatthecurrentexchangeratewhilenonmonetarybalancesheetaccounts(e.g.,stockholder’sequity)areconvertedatthehistoricalexchangerateisthemonetary/nonmonetarymethodComparedtocurrent/noncurrentmethod,thisapproachdifferssubstantiallywithrespecttoaccountslikeinventory,long-termreceivables,andlong-termdebtClassifiesaccountsbasedonsimilarityofattributesratherthansimilarlyofmaturities10-6Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.TemporalMethodTheideathatcurrentandnoncurrentmonetaryaccountsaswellasaccountsthatarecarriedonthebooksatcurrentvalueareconvertedatthecurrentexchangerateisthetemporalmethodAccountscarriedonthebooksathistoricalcostsaretranslatedatthehistoricalexchangerateFixedassetsandinventoryareusuallycarriedathistoricalcosts,andasaresult,thetemporalmethodandthemonetary/nonmonetarymethodwilltypicallyprovidethesametranslation10-7Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.CurrentRateMethodTheideathatallbalancesheetaccountsaretranslatedatthecurrentexchangerateexceptstockholder’sequity,whichistranslatedattheexchangerateonthedateofissuance,isthecurrentratemethodSimplestofalltranslationmethodstoapplyA“plug”equityaccountnamedcumulativetranslationadjustment(CTA)isusedtomakethebalancesheetbalance,sincetranslationgainsorlossesdonotgothroughtheincomestatementaccordingtothismethod10-8Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.FASBStatement8FASB8becameeffectiveonJanuary1,1976Objectivewastomeasureindollarsanenterprise’sassets,liabilities,revenues,orexpensesthataredenominatedinaforeigncurrencyaccordingtoGAAPEssentiallythetemporalmethodoftranslation,withfewsubtletiesTemporalmethodrequirestakingforeignexchangegainsorlossesthroughtheincomestatement.Thereforereportedearningscould(anddid)fluctuatesubstantiallyfromyeartoyear,irritatingexecutives10-9Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.FASBStatement52DuetocontroversarysurroundingFASB8,FASB52wasissuedinDecember1981StatedobjectivesofFASB52:Provideinformationthatisgenerallycompatiblewiththeexpectedeconomiceffectsofaratechangeonanenterprise’scashflowsandequityReflectinconsolidatedstatementsthefinancialresultsandrelationshipoftheindividualconsolidatedentitiesasmeasuredintheirfunctionalcurrenciesinconformitywithU.S.GAAP10-10Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.FunctionalCurrencyversus

ReportingCurrency

ThemethodoftranslationprescribedbyFASB52dependsuponthefunctionalcurrencyusedbytheforeignsubsidiarywhosestatementsaretobetranslatedFunctionalcurrencyisthecurrencyoftheprimaryeconomicenvironmentinwhichtheentityoperatesReportingcurrencyisthecurrencyinwhichtheMNCpreparesitsconsolidatedfinancialstatements10-11Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.TheMechanicsofFASB52TranslationProcessTwo-stageprocess:First,determineinwhichcurrencytheforeignentitykeepsitsbooksIfthelocalcurrencyinwhichtheforeignentitykeepsitsbooksisnotthefunctionalcurrency,remeasurementintothefunctionalcurrencyisrequiredTemporalmethodusedtoaccomplishremeasurementSecond,whentheforeignentity’sfunctionalcurrencyisnotthesameastheparent’scurrency,theforeignentity’sbooksaretranslatedusingthecurrentratemethod10-12Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.FASB52Two-StageProcess10-13Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.HighlyInflationaryEconomiesInhighlyinflationaryeconomies,FASB52requiresforeignentitiestoremeasurefinancialstatementsusingthetemporalmethod“asifthefunctionalcurrencywerethereportingcurrency”Highlyinflationaryeconomyisdefinedas,“onethathascumulativeinflationofapproximately100percentormoreovera3-yearperiod”10-14Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.InternationalAccountingStandardsSinceJanuary2005,allcompaniesdoingbusinessintheEuropeanUnionmustusetheaccountingstandardsdistributedbytheInternationalAccountingStandardsBoard(IASB)SimilartotheFASB,theIASBpublishesitsstandardsinaseriesofpronouncementscalledInternationalFinancialReportingStandardsItalsoadoptedandmaintainsthepronouncementsoftheIASC,theIASC,calledInternationalAccountingStandards(IAS)10-15Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.TranslationversusTransactionExposureSomeitemsthatareasourceoftransactionexposurearealsoasourceoftranslationexposure,whileothersarenotGenerally,itisnotpossibletoeliminatebothtranslationandtransactionexposureBecausetransactionexposureinvolvesrealcashflows,itwouldbeprudenttoconsideritthemoreimportantofthetwoArecentsurveyfound83%ofMNCsplaceda“significant”orthe“most”emphasisontransactionexposurerelativeto37%fortranslationexposure10-16Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.HedgingTranslationExposureIfonedesirestoattempttocontrolaccountingchangesinthehistoricalvalueofnetinvestment,therearetwomethodsfordealingwithresidualtranslationexposure:BalancesheethedgeDerivativeshedge10-17Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.BalanceSheetHedgeNotethattranslationexposureiscurrencyspecific,notentityspecificSourceisamismatchofnetassetsandnetliabilitiesdenominatedinthesamecurrencyAbalancesheethedgeisintendedtoreducetranslationexposureofanMNCbyeliminatingthemismatchofexposednetassets(andexposednetliabilities)denominatedinthesamecurrencyHowever,itmaycreatetransactionexposure10-18Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.DerivativesHedgeAderivativeproduct,suchasaforwardcontract,canbeusedtoattempttohedgeAderivativeshedgetocontroltranslationexposureinvolvesspeculationaboutforeignexchangeratesFASB133establishesaccountingandreportingstandardsforderivativeinstrumentsandhedgingactivitiesToqualityforhedgeaccountingunderFASB133,acompanymustidentifyaclearlinkbetweenanexposureandaderivativeinstrument10-19Copyright?2021bytheMcGraw-HillCompanies,Inc.Allrightsreserved.TranslationExposureversus

OperatingExposureDepreciationoft