Multinational Financial Management Alan Shapiro 7th Edition J.Wiley & Sons Power Points by Joseph F. Greco, Ph.D. California State University, Fullerton 1
CHAPTER 10 MEASURING ACCOUNTING EXPOSURE 2
CHAPTER OVERVIEW I.
ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE
II.ALTERNATIVE CURRENCY TRANSLATION METHODS III.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO.52 3
CHAPTER OVERVIEW (con’t) IV. TRANSACTION EXPOSURE V.
DESIGNING A HEDGING STRATEGY
VI. MANAGING TRANSLATION EXPOSURE VII. MANAGING TRANSACTION EXPOSURE 4
PART I. ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE I. ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE A. Three Types of Exposure 1. Accounting Exposure: when reporting and consolidating financial statements requires conversion from foreign to local currency.
ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE 2. Transaction Exposure: occurs from changes in the value of foreign currency contracts as a result of exchange rate changes.
ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE 3. Operating Exposure arises because exchange rate changes may alter the value of future revenues and costs.
ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE Economic Exposure
= Transaction + Operating Exposures
PART II. 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. 9
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 10
ALTERNATIVE CURRENCY TRANSLATION METHODS 3.
Nonmonetary accounts - use historical rates - Pertains to inventory fixed assets long term investments Income statement accounts - use average exchange rate for the period. 11
ALTERNATIVE CURRENCY TRANSLATION METHODS C. Temporal Method 1. Similar to monetary/nonmonetary method. 2. Uses current method for inventory. 12
ALTERNATIVE CURRENCY TRANSLATION METHODS D.
Current Rate Method all statements use current exchange rate for conversions.
PART III. STATEMENT OF INANCIAL 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.
STATEMENT OF INANCIAL ACCOUNTING STANDARDS NO. 52 C.
Income statement uses 1. Weighted average rate during period or 2.
The rate in effect when revenue and expenses incurred. 15
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52 D. Translation Gains or Losses 1. Recorded in separate equity
on balance sheet. 2. Known as cumulative adjustment
STATEMENT OF INANCIAL 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. 17
STATEMENT OF INANCIAL ACCOUNTING STANDARDS NO. 52 2. Reporting currency the currency the parent firm uses to prepare its financial statements.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52 3.
If foreign subsidiary’ operations are direct extension of parent firm
e.g. Hong Kong assembly plant which sells all its products in the U.S. market. 19
PART IV. 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. 20
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. 21
PART V. DESIGNING A HEDGING STRATEGY III. DESIGNING A HEDGING STRATEGY A. Strategies a function of management’s objectives B. Hedging’s basic objective: reduce/eliminate volatility of earnings as a result of exchange rate changes. 22
DESIGNING A HEDGING STRATEGY C. Hedging exchange rate risk 1. Costs money 2. Should be evaluated as any other purchase of insurance. 3. Taking advantage of tax asymmetries lowers hedging costs. 23
DESIGNING A HEDGING STRATEGY D. Centralization v. Decentralization 1. Important aspects: a. Degree of centralization b. Responsibility for developing c. Implementing the hedging strategy. 2. Maximum benefits accrue from centralizing policy-making, formulation, and implementation. 24
PART VI. MANAGING TRANSLATION EXPOSURE I. MANAGING TRANSLATION EXPOSURE A. 3 Available Methods 1. Adjusting fund flows altering either the amounts or the currencies of the planned cash flows of the parent or its subsidiaries to reduce the firm’s local currency accounting exposure. 25