M13_EITE1342_12E_IM_C13 - Chapter 13 Translation Exposure Questions 13-1 By Any Other Name What does the word translation mean Why is translation

M13_EITE1342_12E_IM_C13 - Chapter 13 Translation Exposure...

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Chapter 13 Translation Exposure Questions 13-1. By Any Other Name. What does the word translation mean? Why is translation exposure sometimes called accounting exposure ? Translation refers to the process by which the financial statements of separately incorporated subsidiaries are added to the financial statements of a parent in order to prepare a consolidated financial statement that will reflect the economic reality of the entire enterprise, rather than just the financial status of one separately incorporated segment. Consolidation of domestic subsidiaries (same country as parent) is simple because only one currency is involved. The financial statements of subsidiaries of a multinational enterprise are kept in other currencies, so consolidation involves adjusting each year for changes in the value of those separate currencies. The process of restating the foreign currency financial statements of a foreign subsidiary is called translation. Because translation occurs as a result of the accounting process, the restatement is most often called “accounting.” Because exchange rates change from one time period to another, imbalances occur. These imbalances may cause an accounting-derived gain or loss, which is taken into the equity section of the parent’s consolidated statement. The possibility of gain or loss gives rise to the word “exposure.” 13-2. Converting Financial Assets. In the context of preparing consolidated financial statements, are the words translate and convert synonyms? They are not synonyms. To translate is to express the value of a financial account (assets, liability, revenue, or expense) originally measured in one currency in another currency. Translation is pure measurement; no transaction is involved. To convert is to engage in a transaction in which an asset or liability originally measured in one currency is physically exchanged for as asset or liability measured in another currency. Exchanging pounds sterling for dollars in the foreign exchange market is converting sterling into dollars. Swapping yen-denominated debt for dollar-denominated debt is converting the debt from one currency to another. 13-3. The Central Problem. What is the central problem in consolidating the financial statements of a foreign subsidiary? The central problem arises from the fact that exchange rates change from one time period to another, combined with the accounting tradition that accounts are supposed to be kept on a historic cost basis. The value in the parent’s home currency of assets and liabilities measured on a historic cost basis in a foreign currency is not clear if the exchange rate has changed. Different countries

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