Translation Risk Exposure Essay

1936 words - 8 pages

What does Translation Exposure Mean?The risk that a company's equities, assets, liabilities or income will change in value as a result of exchange rate changes. This occurs when a firm denominates a portion of its equities, assets, liabilities or income in a foreign currency.Firms have income statements and balance sheets. The balance sheets reflect the valuation of the assets and liabilities of the firm. Changes in those valuations can represent capital gains or losses which may have to be reported in the income statements. An exogenous factor such as a change in interest rates may change the value of assets and liabilities and generate a capital gain or loss. But this capital gain or loss is not connected with any decision about the operation of the company. Once the capital gain or loss occurs there is nothing that can be done about it. The capital gain or loss may alter expectations of future gains or losses and some action might be possibly be warranted, but typically the exogenous changes are deviations from expected conditions and these deviations are in their nature unpredictable.These changes in the valuation of assets and liabilities are particularly a problem in international operations because fluctuations in exchange rates can generate paper gains and losses for the parent company. The valuation of assets and liabilities in foreign operations must be translated into the home country currency. The fluctuations in currency exchange rates could generate significant gains or losses and the entry of these into the income statement could produce a distorted impression of what is happening to the company.The practice concerning these translation or accounting gains or losses is to include them nominally in the income statement but in such a way that the operating characteristics are not disguised or distorted. The difficulty in understanding the procedures is that they are intended to provide for the inclusion of the translation gains or losses in a way that makes them insignificant for decision-making.The various methods for carrying out the translation of foreign accounts are:1. The Current-Rate Method-All assets and liabilities are converted at the current rate of exchange on the date of the balance sheet.-Items in the income statement, which represent flows over the accounting period, are converted at the exchange rate prevailing at the times of accrual. Since this is often not feasible a weighted average exchange rate over the accounting period is used instead.-Dividends and other distributions are converted at the exchange rate prevailing at the time they were paid.2. The Temporal Method-Monetary assets and liabilities (cash, liquid securities, accounts payable and receivable, debt) are converted at the current rate of exchange.-Nonmonetary assets and liabilities (fixed assets and inventory) are translated at historical rates. Thus no accounting capital gains or losses arise from these items.-Income state items are converted at the...

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