22 MANAGING ACCONTING EXPOSURE The general concept of exposure refers to the

22 managing acconting exposure the general concept of

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2.2 MANAGING ACCONTING EXPOSURE The general concept of exposure refers to the degree to which a company is affected by exchange rate changes. Accounting exposure arises from the need, for purposes of reporting and consolidation, to convert the financial statements of foreign operations from the local currencies (LC involved to the home currency (HC). If exchange rates have changed since the previous reporting period, this translation, or restatement, of those assets, liabilities, revenues, expenses, gains, and losses that are denominated in foreign currencies will result in foreign exchange gains or losses. The possible extent of these gains or losses is measure by the translation exposure figures. 2
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Management of accounting exposure centers along the concept of Hedging. a particular currency exposure means establishing an offsetting currency position such that whatever is lost or gained on the original currency exposure is exactly offset by a corresponding foreign exchange gain or loss on the currency hedge. Regardless of what happens to the future exchange rate, therefore, hedging locks in a dollar (home currency) value for the currency exposure. In this way, hedging can protect a firm form unforeseen currency movements. A variety of hedging techniques are available, but before a firm uses them it must decide on which exposures to manage. 2.2.1 MANAGING TRANSLATION EXPOSURE Firms have three available methods for managing their translation exposure: (i) Adjusting fund flows (ii) Entering into forward contracts, and (iii) Exposure netting methods. Essentially the strategy involves increasing hard-currency (likely to appreciate)assets and decreasing soft- currency (likely to depreciate) assets, while simultaneously decreasing hard-currency liabilities and increasing soft-currency liabilities. For example, if a devaluation appears likely, the basic hedging strategy would be executed as follows: Reduce the level of cash, tighten credit terms to decrease accounts payable, and sell the weak currency forward. Funds Adjustment Most techniques for hedging an impending local currency (LC) devaluation reduce LC assets or increase LC liabilities, thereby generating LC cash. If accounting exposure is to be reduced, these funds must be converted into hard currency assets. For example, company will reduce its translation loss if, before an LC devaluation, it converts some of its LC cash holdings to the home currency. This conversion can be accomplished, either directly or indirectly, by means of various funds adjustment techniques. Funds adjustment involves altering either the amounts or the currencies (or both) of the planned cash flows of the parent and/or its subsidiaries to reduce the firm's local currency accounting exposure. If an LC devaluation is anticipated, direct funds-adjustment methods include pricing exports in hard currencies and imports in the local currency, investing in hard-currency securities, and replacing hard- currency borrowings with local currency loans.
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