1、INTERNATIONALFINANCIALMANAGEMENTEUN/RESNICKSecond Edition14Chapter FourteenManagement of Translation ExposureChapter Objective:This chapter discusses the impact that unanticipated changes in exchange rates may have on the consolidated financial statements of the multinational company.Chapter Outline
2、lTranslation MethodslFASB Statement 8lFASB Statement 52lManagement of Translation ExposurelEmpirical Analysis of the Change from FASB 8 to FASB 52Translation MethodslCurrent/Noncurrent MethodlMonetary/Nonmonetary MethodlTemporal MethodlCurrent Rate MethodCurrent/Noncurrent MethodlThe underlying prin
3、cipal is that assets and liabilities should be translated based on their maturity.nCurrent assets translated at the spot rate.nNoncurrent assets translated at the historical rate in effect when the item was first recorded on the books.lThis method of foreign currency translation was generally accept
4、ed in the United States from the 1930s until 1975,at which time FASB 8 became effective.Current/Noncurrent MethodnCurrent assets translated at the spot rate.e.g.DM2=$1nNoncurrent assets translated at the historical rate in effect when the item was first recorded on the books.e.g.DM3=$1Balance SheetL
5、ocal CurrencyCurrent/Noncurrent Cash2,100 DM$1,050 Inventory1,500 DM$750 Net fixed assets3,000 DM$1,000 Total Assets6,600 DM$2,800 Current liabilities1,200 DM$600 Long-Term debt1,800 DM$600 Common stock2,700 DM$900 Retained earnings900 DM$700CTA-Total Liabilities and Equity6,600 DM$2,800 Monetary/No
6、nmonetary MethodlThe underlying principal is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes.lAll monetary balance sheet accounts(cash,marketable securities,accounts receivable,etc.)of a foreign subsidiary are tr
7、anslated at the current exchange rate.lAll other(nonmonetary)balance sheet accounts(owners equity,land)are translated at the historical exchange rate in effect when the account was first recorded.Monetary/Nonmonetary MethodlAll monetary balance sheet accounts are translated at the current exchange r
8、ate.e.g.DM2=$1lAll other balance sheet accounts are translated at the historical exchange rate in effect when the account was first recorded.e.g.DM3=$1Balance SheetLocal CurrencyMonetary/NonmonetaryCash2,100 DM$1,050 Inventory1,500 DM$500 Net fixed assets3,000 DM$1,000 Total Assets6,600 DM$2,550 Cur
9、rent liabilities1,200 DM$600 Long-Term debt1,800 DM$900 Common stock2,700 DM$900 Retained earnings900 DM$0CTA-Total Liabilities and Equity6,600 DM$2,400 Temporal MethodlThe underlying principal is that assets and liabilities should be translated based on how they are carried on the firms books.lBala
10、nce sheet account are translated at the current spot exchange rate if they are carried on the books at their current value.lItems that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books.Temporal Met
11、hodlItems carried on the books at their current value are translated at the spot exchange rate.e.g.DM2=$1lItems that are carried on the books at historical costs are translated at the historical exchange rates.e.g.DM3=$1Balance SheetLocal CurrencyTemporalCash2,100 DM$1,050 Inventory1,500 DM$900Net f
12、ixed assets3,000 DM$1,000 Total Assets6,600 DM$2,950 Current liabilities1,200 DM$600 Long-Term debt1,800 DM$900 Common stock2,700 DM$900 Retained earnings900 DM$0CTA-Total Liabilities and Equity6,600 DM$2,400 Current Rate MethodlAll balance sheet items(except for stockholders equity)are translated a
13、t the current exchange rate.lVery simple method in application.lA“plug”equity account named cumulative translation adjustment is used to make the balance sheet balance.Current Rate MethodlAll balance sheet items(except for stockholders equity)are translated at the current exchange rate.lA“plug”equit
14、y account named cumulative translation adjustment is used to make the balance sheet balanceBalance SheetLocal CurrencyCurrent RateCashDM2,100$1,050 InventoryDM1,500$750 Net fixed assetsDM3,000$1,500 Total AssetsDM6,600$3,300 Current liabilitiesDM1,200$600 Long-Term debtDM1,800$900 Common stockDM2,70
15、0$900 Retained earningsDM900$360 CTA-$540 Total Liabilities and EquityDM6,600$3,300 How Various Translation Methods Deal with a Change from DM3 to DM2=$1Balance SheetLocal CurrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateCash2,100 DM$1,050$1,050$1,050$1,050 Inventory1,500 DM$750$50
16、0$900$750 Net fixed assets3,000 DM$1,000$1,000$1,000$1,500 Total Assets6,600 DM$2,800$2,550$2,950$3,300 Current liabilities1,200 DM$600$600$600$600 Long-Term debt1,800 DM$600$900$900$900 Common stock2,700 DM$900$900$900$900 Retained earnings900 DM$700$150$550$360CTA-$540 Total Liabilities and Equity
17、6,600 DM$2,800$2,550$2,950$3,300 Spot exchange rateearningsHow Various Translation Methods Deal with a Change from DM3 to DM2=$1Balance SheetLocal CurrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateCash2,100 DM$1,050$1,050$1,050$1,050 Inventory1,500 DM$750$500$900$750 Net fixed asset
18、s3,000 DM$1,000$1,000$1,000$1,500 Total Assets6,600 DM$2,800$2,550$2,950$3,300 Current liabilities1,200 DM$600$600$600$600 Long-Term debt1,800 DM$600$900$900$900 Common stock2,700 DM$900$900$900$900 Retained earnings900 DM$700$150$550$360CTA-$540 Total Liabilities and Equity6,600 DM$2,800$2,550$2,95
19、0$3,300 Book value of inventory at spot exchange rateBook value of inventory historic rateCurrent value of inventory at spot exchange rate.earningsHow Various Translation Methods Deal with a Change from DM3 to DM2=$1Balance SheetLocal CurrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent Ra
20、teCash2,100 DM$1,050$1,050$1,050$1,050 Inventory1,500 DM$750$500$900$750 Net fixed assets3,000 DM$1,000$1,000$1,000$1,500 Total Assets6,600 DM$2,800$2,550$2,950$3,300 Current liabilities1,200 DM$600$600$600$600 Long-Term debt1,800 DM$600$900$900$900 Common stock2,700 DM$900$900$900$900 Retained earn
21、ings900 DM$700$150$550$360CTA-$540 Total Liabilities and Equity6,600 DM$2,800$2,550$2,950$3,300 historic ratespot exchange rate.earningsHow Various Translation Methods Deal with a Change from DM3 to DM2=$1Balance SheetLocal CurrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateCash2,100
22、 DM$1,050$1,050$1,050$1,050 Inventory1,500 DM$750$500$900$750 Net fixed assets3,000 DM$1,000$1,000$1,000$1,500 Total Assets6,600 DM$2,800$2,550$2,950$3,300 Current liabilities1,200 DM$600$600$600$600 Long-Term debt1,800 DM$600$900$900$900 Common stock2,700 DM$900$900$900$900 Retained earnings900 DM$
23、700$150$550$360CTA-$540 Total Liabilities and Equity6,600 DM$2,800$2,550$2,950$3,300 spot rateearningsHow Various Translation Methods Deal with a Change from DM3 to DM2=$1Balance SheetLocal CurrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateCash2,100 DM$1,050$1,050$1,050$1,050 Invent
24、ory1,500 DM$750$500$900$750 Net fixed assets3,000 DM$1,000$1,000$1,000$1,500 Total Assets6,600 DM$2,800$2,550$2,950$3,300 Current liabilities1,200 DM$600$600$600$600 Long-Term debt1,800 DM$600$900$900$900 Common stock2,700 DM$900$900$900$900 Retained earnings900 DM$700$150$550$360CTA-$540 Total Liab
25、ilities and Equity6,600 DM$2,800$2,550$2,950$3,300 spot ratehistorical rateearningsHow Various Translation Methods Deal with a Change from DM3 to DM2=$1Balance SheetLocal CurrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateCash2,100 DM$1,050$1,050$1,050$1,050 Inventory1,500 DM$750$500
26、$900$750 Net fixed assets3,000 DM$1,000$1,000$1,000$1,500 Total Assets6,600 DM$2,800$2,550$2,950$3,300 Current liabilities1,200 DM$600$600$600$600 Long-Term debt1,800 DM$600$900$900$900 Common stock2,700 DM$900$900$900$900 Retained earnings900 DM$700$150$550$360CTA-$540 Total Liabilities and Equity6
27、,600 DM$2,800$2,550$2,950$3,300 historical rateearningsHow Various Translation Methods Deal with a Change from DM3 to DM2=$1Balance SheetLocal CurrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateCash2,100 DM$1,050$1,050$1,050$1,050 Inventory1,500 DM$750$500$900$750 Net fixed assets3,0
28、00 DM$1,000$1,000$1,000$1,500 Total Assets6,600 DM$2,800$2,550$2,950$3,300 Current liabilities1,200 DM$600$600$600$600 Long-Term debt1,800 DM$600$900$900$900 Common stock2,700 DM$900$900$900$900 Retained earnings900 DM$700$150$550$360CTA-$540 Total Liabilities and Equity6,600 DM$2,800$2,550$2,950$3,
29、300 From income statementearningsHow Various Translation Methods Deal with a Change from DM3 to DM2=$1Balance SheetLocal CurrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateCash2,100 DM$1,050$1,050$1,050$1,050 Inventory1,500 DM$750$500$900$750 Net fixed assets3,000 DM$1,000$1,000$1,00
30、0$1,500 Total Assets6,600 DM$2,800$2,550$2,950$3,300 Current liabilities1,200 DM$600$600$600$600 Long-Term debt1,800 DM$600$900$900$900 Common stock2,700 DM$900$900$900$900 Retained earnings900 DM$700$150$550$360CTA-$540 Total Liabilities and Equity6,600 DM$2,800$2,550$2,950$3,300 Under the current
31、rate method,a“plug”equity account named cumulative translation adjustment makes the balance sheet balance.earningsHow Various Translation Methods Deal with a Change from DM3 to DM2=$1For notes,see Exhibit 14.1Income StatementLocal CurrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateSa
32、les10,000 DM$4,000$4,000$4,000$4,000COGS7,500 DM$3,000$2,500$3,000$3,000Depreciation1,000 DM$333$333$333$400Net operating income1,500 DM$667$1,167$667$600Income tax(40%)600 DM$267$467$267$240Profit after tax900 DM$400$700$400$360$300-$550$150Net income900 DM$700$150$550$360Dividends0 DM$0$0$0$0Addit
33、ion to Retained Earnings900 DM$700$150$550$360Foreign exchange gain(loss)Sales translate at average exchange rate over the period,DM2.50=$1How Various Translation Methods Deal with a Change from DM3 to DM2=$1For notes,see Exhibit 14.1Income StatementLocal CurrencyCurrent/Noncurrent Monetary/Nonmonet
34、aryTemporalCurrent RateSales10,000 DM$4,000$4,000$4,000$4,000COGS7,500 DM$3,000$2,500$3,000$3,000Depreciation1,000 DM$333$333$333$400Net operating income1,500 DM$667$1,167$667$600Income tax(40%)600 DM$267$467$267$240Profit after tax900 DM$400$700$400$360$300-$550$150Net income900 DM$700$150$550$360D
35、ividends0 DM$0$0$0$0Addition to Retained Earnings900 DM$700$150$550$360Foreign exchange gain(loss)Translate at DM2.50=$1Translate at new exchange rate,DM2.00=$1How Various Translation Methods Deal with a Change from DM3 to DM2=$1For notes,see Exhibit 14.1Income StatementLocal CurrencyCurrent/Noncurr
36、ent Monetary/NonmonetaryTemporalCurrent RateSales10,000 DM$4,000$4,000$4,000$4,000COGS7,500 DM$3,000$2,500$3,000$3,000Depreciation1,000 DM$333$333$333$400Net operating income1,500 DM$667$1,167$667$600Income tax(40%)600 DM$267$467$267$240Profit after tax900 DM$400$700$400$360$300-$550$150Net income90
37、0 DM$700$150$550$360Dividends0 DM$0$0$0$0Addition to Retained Earnings900 DM$700$150$550$360Foreign exchange gain(loss)Translate at DM3=$1Translate at average exchange rate,DM2.5=$1How Various Translation Methods Deal with a Change from DM3 to DM2=$1For notes,see Exhibit 14.1Income StatementLocal Cu
38、rrencyCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateSales10,000 DM$4,000$4,000$4,000$4,000COGS7,500 DM$3,000$2,500$3,000$3,000Depreciation1,000 DM$333$333$333$400Net operating income1,500 DM$667$1,167$667$600Income tax(40%)600 DM$267$467$267$240Profit after tax900 DM$400$700$400$360$300
39、-$550$150Net income900 DM$700$150$550$360Dividends0 DM$0$0$0$0Addition to Retained Earnings900 DM$700$150$550$360Foreign exchange gain(loss)Note the effect on after-tax profit.How Various Translation Methods Deal with a Change from DM3 to DM2=$1For notes,see Exhibit 14.1Income StatementLocal Currenc
40、yCurrent/Noncurrent Monetary/NonmonetaryTemporalCurrent RateSales10,000 DM$4,000$4,000$4,000$4,000COGS7,500 DM$3,000$2,500$3,000$3,000Depreciation1,000 DM$333$333$333$400Net operating income1,500 DM$667$1,167$667$600Income tax(40%)600 DM$267$467$267$240Profit after tax900 DM$400$700$400$360$300-$550
41、$150Net income900 DM$700$150$550$360Dividends0 DM$0$0$0$0Addition to Retained Earnings900 DM$700$150$550$360Foreign exchange gain(loss)Note the effect that foreign exchange gains(losses)has on net income.FASB Statement 8lEssentially the temporal method,with some subtleties.nSuch as translating inven
42、tory at historical rates,which is a hassle.lRequires taking foreign exchange gains and losses through the income statement.lThis leads to variability in reported earnings.lWhich leads to irritated corporate executives.FASB Statement 52lThe Mechanics of the FASB 52 Translation ProcessnFunction Curren
43、cynReporting CurrencylHighly Inflationary EconomiesThe Mechanics of FASB Statement 52lFunction CurrencynThe currency that the business is conducted in.lReporting CurrencynThe currency in which the MNC prepares its consolidated financial statements.The Mechanics of FASB Statement 52lTwo-Stage Process
44、nFirst,determine in which currency the foreign entity keeps its books.nIf the local currency in which the foreign entity keeps its books is not the functional currency,remeasurement into the functional currency is required.nSecond,when the foreign entitys functional currency is not the same as the p
45、arents currency,the foreign entitys books are translated using the current rate method.Current RateTranslationParents CurrencyForeign entitys books kept in?Parents Currency Functional Currency?Local currencyTemporal RemeasurementParents currency NonparentCurrencyThird currencyThe Mechanics of FASB S
46、tatement 52Highly Inflationary EconomieslForeign entities are required to remeasure financial statements using the temporal method“as if the functional currency were the reporting currency”.Management of Translation ExposurelTranslation Exposure vs.Transaction ExposurelHedging Translation ExposurenB
47、alance Sheet HedgenDerivatives HedgelTranslation Exposure vs.Operating ExposureTranslation Exposure versus Transaction ExposurelTranslation ExposurenThe effect that unanticipated changes in exchange rates has on the firms consolidated financial statements.nAn accounting issue.lTransaction ExposurenT
48、he effect that unanticipated changes in exchange rates has on the firms cash flows.nA finance issue and the subject of Chapter 13.lIt is generally not possible to eliminate both translation exposure and transaction exposure.Hedging Translation ExposurelIf the managers of the firm wish to manage thei
49、r accounting numbers as well as their business,they have two methods for dealing with translation exposure.nBalance Sheet HedgenDerivatives HedgeBalance Sheet HedgelEliminates the mismatch between net assets and net liabilities denominated in the same currency.lMay create transaction exposure,howeve
50、r.Derivatives HedgelAn example would be the use of forward contracts with a maturity of the reporting period to attempt to manage the accounting numbers.lUsing a derivatives hedge to control translation exposure really involves speculation about foreign exchange rate changes,however.Translation Expo
