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Measuring Accounting Exposure

Measuring Accounting Exposure. Chapter 9. PART I. ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE. I. ALTERNATIVE MEASURES A. TYPES 1. Accounting Exposure: when reporting and consolidating financial statements requires conversion from foreign to local currency.

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Measuring Accounting Exposure

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  1. Measuring Accounting Exposure Chapter 9

  2. PART I. ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE • I. ALTERNATIVE MEASURES • A. TYPES • 1. Accounting Exposure: • when reporting and consolidating financial statements requires conversion from foreign to local currency. • 2. Transaction Exposure: • occurs from changes in value of • foreign currency contracts from exchange rate changes.

  3. ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE • 3. Operating Exposure • arises because exchange rate • changes alter the value of future revenues and costs. • 4. Economic Exposure • = Transaction + Operating Exposures

  4. ALTERNATIVE CURRENCY TRANSLATION METHODS • I. FOUR METHODS OF TRANSLATION • A. Current/Noncurrent Method • 1. Current accounts use current exchange rate for conversion. • 2. Income statement accounts use • average exchange rate for the • period. • 3. Noncurrent assets and liabilities at • historical exchange rates.

  5. ALTERNATIVE CURRENCY TRANSLATION METHODS • B. Monetary/Nonmonetary Method • 1. Monetary accounts use current • rate • 2. Pertains to • - cash • - accounts receivable • - accounts payable • - long term debt

  6. ALTERNATIVE CURRENCY TRANSLATION METHODS • 3. Nonmonetary accounts • - use historical rates • - Pertains to • inventory • fixed assets • long term investments • 4. Income statement accounts • - use average exchange rate for the period.

  7. ALTERNATIVE CURRENCY TRANSLATION METHODS • C. Temporal Method • 1. Similar to monetary/nonmonetary • method. • 2. Current method can be used for • inventory shown at market value. • D. Current Rate Method • all statements use current exchange rate • for conversions.

  8. PART III.STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 8 • I. FASB NO. 8 • A. Temporal method utilized • B. Translation gains or losses • 1. Reported on income statement • 2. Result: net income greatly affected by exchange rate volatility.

  9. PART IV.STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52 • I. FASB NO. 52 • A. Dissatisfaction with FASB No. 8 • true profitability often disguised by • exchange rate volatility. • B. Balance sheet translation uses current • rate method. • C. Income statement uses • 1. Weighted average rate during period or • 2. Use rate in effect when revenue • and expenses incurred.

  10. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52 • D. Translation Gains or Losses • 1. Recorded in separate equity account on balance sheet. • 2. Known as cumulative translation adjustment account.

  11. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52 • E. New Distinction under FASB No. 52: • functional v. reporting currency • 1. Functional currency for foreign subsidiary: • the currency used in the primary • economic environment in • which it operates. • 2. Reporting currency • the currency the parent firm uses to • prepare its financial statements.

  12. PART V.TRANSACTION EXPOSURE • I. WHEN DOES IT OCCUR? • A. From the time of agreement to time of • payment. • B. Arises from possibility of exchange rate • gains and losses from the transaction.

  13. TRANSACTION EXPOSURE • II. MEASUREMENT • A. Currency by currency • b. Equals the difference between • 1. The contractually-fixed invoice • amount in a specific currency • 2. The final payment amount • denominated in current exchange • rate for the specific currency.

  14. PART VI.ACCOUNTING PRACTICE AND ECONOMIC REALITY • I. Accounting v. Economic Exposure • measurement of exchange rate risk indicates • that a major difference exists. • A. Accounting exposure • reflects past decisions of the firm. • B. Economic exposure • 1. Focuses on future impact of exchange rate changes. • 2. Not all future cash flows appear on • the firm’s balance sheet.

  15. ACCOUNTING PRACTICE AND ECONOMIC REALITY • II. Recommendations for International • Business Executives • A. There is no relationship between • Info from historical accounting techniques • and • The firm’s actual operating results • B. Chief executives should • base management decisions on the • economic effects of exchange rate change.

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