2.2MANAGING ACCONTING EXPOSUREThe general concept of exposure refers to the degree to which a company is affected by exchange ratechanges. Accounting exposure arises from the need, for purposes of reporting and consolidation, to convertthe 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 currencieswill result in foreign exchange gains or losses. The possible extent of these gains or losses is measure bythe translation exposure figures.2
Management of accounting exposure centers along the concept of Hedging. a particular currency exposuremeans establishing an offsetting currency position such that whatever is lost or gained on the originalcurrency exposure is exactly offset by a corresponding foreign exchange gain or loss on the currencyhedge. Regardless of what happens to the future exchange rate, therefore, hedging locks in a dollar (homecurrency) value for the currency exposure. In this way, hedging can protect a firm form unforeseencurrency movements.A variety of hedging techniques are available, but before a firm uses them it must decide on whichexposures to manage.2.2.1MANAGING TRANSLATION EXPOSUREFirms 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 andincreasing soft-currency liabilities. For example, if a devaluation appears likely, the basic hedging strategywould be executed as follows: Reduce the level of cash, tighten credit terms to decrease accounts payable,and sell the weak currency forward.Funds AdjustmentMost techniques for hedging an impending local currency (LC) devaluation reduce LC assets orincrease LC liabilities, thereby generating LC cash. If accounting exposure is to be reduced, thesefunds must be converted into hard currency assets. For example, company will reduce its translationloss if, before an LC devaluation, it converts some of its LC cash holdings to the home currency. Thisconversion can be accomplished, either directly or indirectly, by means of various funds adjustmenttechniques.Funds adjustment involves altering either the amounts or the currencies (or both) of the planned cashflows of the parent and/or its subsidiaries to reduce the firm's local currency accounting exposure. If anLC devaluation is anticipated, direct funds-adjustment methods include pricing exports in hardcurrencies and imports in the local currency, investing in hard-currency securities, and replacing hard-currency borrowings with local currency loans.