Measuring Accounting Exposure

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Measuring Accounting Exposure

• Chapter 9

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PART I. ALTERNATIVE MEASURES OF FOREIGN EXCHANGE
EXPOSURE

• I. ALTERNATIVE MEASURES
• A. 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 of
• foreign currency contracts from exchange
  rate changes.

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ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE

• 3. Operating Exposure
• arises because exchange rate
• changes alter the value of future revenues
  and costs.
• 4. Economic Exposure
• Transaction Operating
  Exposures

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ALTERNATIVE CURRENCY TRANSLATION METHODS

• I. FOUR METHODS OF TRANSLATION
• A. Current/Noncurrent Method
• 1. 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.

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ALTERNATIVE CURRENCY TRANSLATION METHODS

• B. Monetary/Nonmonetary Method
• 1. Monetary accounts use current
• rate
• 2. Pertains to
• - cash
• - accounts receivable
• - accounts payable
• - long term debt

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ALTERNATIVE CURRENCY TRANSLATION METHODS

• 3. Nonmonetary accounts
• - use historical rates
• - Pertains to
• inventory
• fixed assets
• long term investments
• 4. Income statement accounts
• - use average exchange rate for the
  period.

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ALTERNATIVE CURRENCY TRANSLATION METHODS

• C. Temporal Method
• 1. Similar to monetary/nonmonetary
• method.
• 2. Current method can be used for
• inventory shown at market value.
• D. Current Rate Method
• all statements use current exchange rate
• for conversions.

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PART III.STATEMENT OF FINANCIAL ACCOUNTING
STANDARDS NO. 8

• I. FASB NO. 8
• A. Temporal method utilized
• B. Translation gains or losses
• 1. Reported on income statement
• 2. Result net income greatly
  affected by exchange rate volatility.

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PART IV.STATEMENT OF FINANCIAL ACCOUNTING
STANDARDS NO. 52

• I. FASB NO. 52
• A. Dissatisfaction with FASB No. 8
• true profitability often disguised by
• exchange 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.

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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.

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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.

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PART V.TRANSACTION EXPOSURE

• I. 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.

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TRANSACTION EXPOSURE

• II. MEASUREMENT
• A. Currency by currency
• b. Equals the difference between
• 1. The contractually-fixed invoice
• amount in a specific currency
• 2. The final payment amount
• denominated in current exchange
• rate for the specific currency.

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PART VI.ACCOUNTING PRACTICE AND ECONOMIC REALITY

• I. Accounting v. Economic Exposure
• measurement of exchange rate risk indicates
• that 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 firms balance sheet.

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ACCOUNTING PRACTICE AND ECONOMIC REALITY

• II. Recommendations for International
• Business Executives
• A. There is no relationship between
• Info from historical accounting techniques
• and
• The firms actual operating results
• B. Chief executives should
• base management decisions on the
• economic effects of exchange rate change.