Você está na página 1de 12
Translation Exposure
Translation Exposure
(or chapter 10)
(or chapter 10)

Agenda

  • How translation exposure arises?

  • Functional currency?

  • Current Rate Method vs. Temporal Method.

  • Balance Sheet Hedge?

  • Earnings Management.

Translation Exposure

  • Potential for increase/ decrease in parent’s net worth &

reported income due to forex change.

  • Translation method differ:

based on operation

Integrated Foreign Entity: cash flow integrated w/ parent Self-sustaining Foreign Entity independent of parent

based on functional currency (currency of economic activity)

Which currency is functional? Not a discretionary management decision!

Cash flow Sales prices Sales market Expenses Financing Intercompany tranactions

Translation Methods

Current (Closing) Rate Method

Temporal Method

Assets & Liabilities: translate @ current rate (as of balance sheet date).

Assets & Liabilities:

-Monetary: translate @ current rates.

-Non-monetary (inventory & fixed assets):

@ historical rates

Income statement Items: translate @ actual rate when items incurred.

Income Statement Items: translated @ average rates except for depreciation & cost of goods sold (@ historical rates)

Distributions: dividends translated @ the rate on date of payment.

Distributions: dividends translated @ the rate on date of payment.

Equity Items: Common stock & Paid-in capital translated @ historical rates. Retained earnings +/- income/loss for the year.

Equity Items: Common stock & Paid-in capital translated @ historical rates. Retained earnings +/- income/loss +/- imbalance from translation.

Translation Adjustments: not included into consolidated income but in equity reserve account.

Translation Adjustments: unrealized forex gains/ losses included in primary earnings.

4

US Translation Procedures

Purpose: Need to translate foreign subs statement into US$

If subs financial statements kept in $, no need for translation.

Is local currency functional currency?

US Translation Procedures Purpose: Need to translate foreign subs statement into US$ If subs financial statements
US Translation Procedures Purpose: Need to translate foreign subs statement into US$ If subs financial statements
US Translation Procedures Purpose: Need to translate foreign subs statement into US$ If subs financial statements
No
No

Yes

No

Yes

Is US$ functional currency?

1. Remeasure from foreign

currency to functional by temporal method 2. Translate to US$ by current rate method

Use current rate method

Remeasure to US$

by temporal method

US Translation Procedures Purpose: Need to translate foreign subs statement into US$ If subs financial statements
US Translation Procedures Purpose: Need to translate foreign subs statement into US$ If subs financial statements

Hyperinflation Countries

  • FAS #52: US subs in countries where cumulative

inflation 100%+ over 3 years use temporal method

Why? B/c if current rate method, depreciation understated & profits overstated => book value of PP&E would disappear.

  • International Practices:

Integrated subsidiaries: re-measure using temporal method.

Self-sustaining subsidiaries: translate by current rate method.

Translation Example

  • Suppose EUR depreciated 16.67% from $1.2/EUR to $1.0/EUR

  • Functional currency EUR, Parent: US$

  • PP&E, common stock acquired @ $1.276/EUR

  • Inventory purchased/manufactured @ $1.218/EUR

  • Exposed assets:asset whose value drops w/ depreciation of functional currency & rises w/ appreciation of functional currency.

  • Net exposed assets: exposed assets exposed liability

  • Implications:

Appreciation -> increase net exposed assets. Depreciation -> decrease net exposed assets.

BALANCE SHEET TRANSLATION

CURRENT RATE METHOD

CURRENT RATE METHOD

  • 1.00 $

4,800,000

  • 1.20 $

5,760,000

4,800,000

Net plant & equipment

  • 1.00 $

2,400,000

$

$ $/EUR) ($/EUR) EUR Assets $ Jan-03 Dec-02
$
$/EUR)
($/EUR)
EUR
Assets
$
Jan-03
Dec-02
1.00 $ $ 1,600,000 1.00 $ 1,920,000 1.20 $ 1,920,000 Total € 12,000,000 14,400,000 € 800,000
1.00 $
$
1,600,000
1.00 $
1,920,000
1.20 $
1,920,000
Total
€ 12,000,000
14,400,000
€ 800,000
€ 1,600,000
€ 1,600,000
12,000,000
$
Liabilities & Net Worth
1,600,000
1.00 $
Accounts payable
Short-term bank loan
Lont-term debt
1.20 $
960,000
1.20 $
800,000
1.00 $
1.20 2,880,000
Cash
€ 1,600,000
1,920,000
1.20 $
1,600,000
Accounts receivable
3,200,000
3,840,000
1.20 $
3,200,000
1.00 $
Inventory
2,400,000

Retained earnings

Common stock

Retained earnings Common stock

CTA account

€ 12,000,000

€ 6,200,000

€ 1,800,000

Total

$

7,440,000

(136,800)

(1,736,800)

$

$

12,000,000

$

14,400,000

$ 7,440,000 (136,800) (1,736,800) $ $ 12,000,000 $ 14,400,000 2,296,800 1.28 $ 1.28 2,296,800 $ 1.20
2,296,800 1.28 $ 1.28 2,296,800 $ 1.20 7,440,000 1.20 $
2,296,800
1.28 $
1.28
2,296,800
$
1.20
7,440,000
1.20 $
TEMPORAL METHOD
TEMPORAL METHOD
TEMPORAL METHOD
TEMPORAL METHOD
TEMPORAL METHOD
Assets EUR

Assets

EUR

Accounts receivable

€ 1,600,000

3,200,000

Cash

 

Inventory

Net plant & equipment

1.20

13,848,000

$

14,808,000

$

7,711,200

960,000

$

$

1,600,000

1.00

$

1,920,000

$

1,600,000

1.00

1.20

1,920,000

1.20

$

$

800,000

1.00

$

2,296,800 $ 7,711,200 1.20 $ 1.28 2,296,800 1.28 $
2,296,800
$
7,711,200
1.20 $
1.28
2,296,800
1.28 $
8 (160,000) $ 14,808,000 $ 13,848,000 $
8
(160,000)
$
14,808,000
$
13,848,000
$
1.00 $ 1.00 $ 3,840,000 1.20 $ 3,200,000 1.20 $ 1,600,000 Dec-02 Jan-03 ($/EUR) $ $/EUR)
1.00 $
1.00 $
3,840,000
1.20 $
3,200,000
1.20 $
1,600,000
Dec-02
Jan-03
($/EUR)
$
$/EUR)
$
1,920,000
$ 2,923,200 1.22 1.22 $ 2,923,200 6,124,800 $ 6,124,800 1.28 1.28 $
$
2,923,200
1.22
1.22 $
2,923,200
6,124,800
$
6,124,800
1.28
1.28 $

2,400,000

4,800,000

Total

Accounts payable

Short-term bank loan

Lont-term debt

Retained earnings

Common stock

€ 12,000,000

Liabilities & Net Worth

€ 800,000

€ 1,600,000

€ 1,600,000

€ 1,800,000

€ 6,200,000

CTA account (loss)

 

Total

€ 12,000,000

 

How to manage accounting exposure?

  • Balance Sheet Hedge requires equal amount of exposed forex assets & liabilities on consolidated balance sheet

Termed monetary balance under temporal method Cost:

Costly if borrowing cost of parent higher.

  • How to manage it if depreciation expected?

Reduce EUR exposed assets, no change on EUR exposed liab. Increase EUR exposed liabilities, no change on EUR exposed assets.

  • When balance sheet hedge justified?

Subs to be liquidated Firm has debt covenants to maintain debt/equity ratios

Management evaluated on basis of certain income statement and balance sheet measures

Subs operating in hyperinflationary country

For example…

For example… 10

10

Earnings Management

EARNINGS INCRASING

LOSS AVOIDANCE
LOSS AVOIDANCE

EARNINGS SMOOTHING

LOSS AVOIDANCE

11

Things to remember…

  • How translation exposure arises?

  • Functional currency?

  • Current Rate Method vs. Temporal Method.

  • Balance sheet hedge

  • Earnings Management.