Translation Exposure Management

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Opening Case 10. Main Features of Accounting Exposure

Translation exposure has these main features:

1 Because accounting exposure, commonly known as translation exposure, is based on book values only, it does not reflect the true economic value a company has at risk. By the same token, the gains and losses of foreign-exchange trading as measured by this concept bear no relationship to the real impact exchange rate changes have on the value of the firm itself. They are purely of a paper nature.

2 In connection with the above feature, accounting exposure is incapable of encompassing the various and complex ways in which exchange rate changes will really affect a company.

3 Accounting exposure is a function of the method used in translating foreign-currency financial statements. The application of different translation methods may lead to very different account exposures and to different bases for corporate decision-making.

4 Accounting exposure is a concept that is static and historically oriented rather than dynamic and geared toward the future; in other words, it measures assets and liabilities for given past dates instead of flows of currencies over future periods of time. Under this accounting concept, the exposure of two companies may show exactly the same values although they can be in different economic situations and would be affected differently by exchange rate changes.

Source: Martin Glau, "Strategic Management of Exchange Rate Risks," Long Range Planning, Aug.

Translation exposure, sometimes called accounting exposure, measures the effect of an exchange rate change on published financial statements of a firm. Foreign-currency assets and liabilities that are translated at the current exchange rate are considered to be exposed. In accounting terms, the difference between exposed assets and exposed liabilities is frequently called net exposure. If exposed assets are greater than exposed liabilities, foreign-currency depreciations will result in exchange losses and foreign-currency appreciations will produce exchange gains. On the other hand, if exposed assets are smaller than exposed liabilities, foreign-currency depreciations will lead to exchange gains and foreign-currency appreciations will lead to exchange losses.

This chapter has three major sections. The first section discusses four translation rules commonly used by multinational companies (MNCs) to consolidate their worldwide operations into home currency. The second section analyzes major differences between two major translation rules: FASB 8 and FASB 52. The third section considers some techniques designed to reduce translation risk.

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