IBF Ch 12 and 13 - L9(Ch12 Managing Translation Exposure...

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L9 (Ch12): Managing Translation Exposure and Accounting for Financial Transactions Translation Exposure Translation exposure refers to the impact of exchange rate changes on the parent firm’s consolidated financial statements also called accounting exposure. Balance Sheet Translation Exposure Foreign assets and liabilities translated at the current exchange rate have a translation exposure to currency risk. Those translated at historical exchange rates do not have translation exposure. Foreign currency assets are positively exposed to the foreign currency value Foreign currency liabilities are negatively exposed to the foreign currency value Translation Accounting Financial accounting strives for two goals; reliability and relevance . Reliability. Verifiable & accurate representation. Relevance. Timely & predictive in nature. Measuring Translation Exposure Translation accounting can fall into one of three categories: The current/noncurrent method pre. 1976 The temporal or monetary/nonmonetary method FAS#8, 1976. The current rate method FAS#52, 1982.
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Assets Current/noncurrent Monetary/Nonmonetary Current rate Short-term financial assets C C C Long-term financial assets H C C Real assets H H C Liabilities and owner’s equity Short-term financial liabilities C C C Long-term financial liabilities H C C Net worth (common equity H H H Translation gains or losses Flowed through the income statement Flowed through the income statement Reported as a cumulative translation adjustment in net worth The Problem with FAS#8 Translation gains or losses were reflected in reported earnings on the income statement o Changes in translated balance sheet account could overwhelm operating performance , sometimes resulting in operating losses even during profitable years. o Unfair to managers as they had no control . FAS#52 solves this problem. FAS#52 Any imbalances between book value of assets and liabilities is recorded as a separate equity account called the cumulative translation adjustment (CTA)
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Hedging Translation Exposure The firm should only consider hedging risk exposures that are related to firm value. Hedging can increase firm value by reducing expected taxes, costs of financial distress, or agency costs there is no value in hedging non - cash transactions that do not cost or risk cash Information-Based Reasons for Hedging Translation Exposure Management of translation exposure may be justifiable in circumstances where currency risk can
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IBF Ch 12 and 13 - L9(Ch12 Managing Translation Exposure...

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