S dollars and hold those dollars itself or 2 it could

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Intermediate Accounting: Reporting and Analysis
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Chapter 18 / Exercise 18-23
Intermediate Accounting: Reporting and Analysis
Jones/Wahlen
Expert Verified
Ganado Europe could exchange the acquired euros for U.S. dollars and hold those dollars itself, or (2) it could transfer the borrowed euros to Ganado Corporation, perhaps as a euro dividend or as repayment of intracompany debt. Ganado Corporation could then exchange the euros for dollars. In some countries, local monetary authorities will not allow their currency to be freely exchanged. An alternative would be for Ganado Corporation or a sister subsidiary to borrow the euros, thus keeping the euro debt entirely off Ganado’s books. However, the second step is still essential to eliminate euro exposure; the borrowing entity must exchange the euros for dollars or other unexposed assets. Any such borrowing should be coordinated with all other euro borrowings to avoid the possibility that one subsidiary is borrowing euros to reduce translation exposure at the same time as another subsidiary is repaying euro debt. (Note that euros can be “borrowed,” by simply delaying repayment of existing euro debt; the goal is to increase euro debt, not to borrow in a literal sense.) Temporal Method. If translation is by the temporal method, the much smaller amount of only 800,000 need be borrowed. As before, Ganado Europe could use the proceeds of the loan to acquire U.S. dollars. However, Ganado Europe could also use the proceeds to acquire inventory or fixed assets in Europe. Under the temporal method, these assets are not regarded as exposed and do not drop in dollar value when the euro depreciates. When Is a Balance Sheet Hedge Justified?
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Intermediate Accounting: Reporting and Analysis
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Chapter 18 / Exercise 18-23
Intermediate Accounting: Reporting and Analysis
Jones/Wahlen
Expert Verified
If a firm’s subsidiary is using the local currency as the functional currency, the following circumstances could justify when to use a balance sheet hedge: The foreign subsidiary is about to be liquidated, so that value of its CTA would be realized. The firm has debt covenants or bank agreements that state the firm’s debt/equity ratios will be maintained within specific limits. Management is evaluated based on certain income statement and balance sheet measures that are affected by translation losses or gains. The foreign subsidiary is operating in a hyperinflationary environment. If a firm is using the parent’s home currency as the functional currency of the foreign subsidiary, all transaction gains/losses are passed through to the income statement. Hedging this consolidated income to reduce its variability may be important to investors and bond rating agencies. In the end, accounting exposure is a topic of great concern and complex choices for all multinationals. As demonstrated by Global Finance in Practice 11.2 , despite the best of intentions and structures, business itself may dictate hedging outcomes. GLOBAL FINANCE IN PRACTICE 11.2 When Business Dictates Hedging Results GM Asia, a regional subsidiary of GM Corporation, U.S., held major corporate interests in a variety of countries and companies, including Daewoo Auto of South Korea. GM had acquired control of Daewoo’s automobile operations in 2001. The following years had been very good for the Daewoo unit, and by 2009, GM Daewoo was selling automobile components and vehicles to more than 100 countries.

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