Page 184 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 11: Management of Translation Exposure

functional currency. If the foreign affiliate’s operations were an extension of the US parent’s Notes
operations, the functional currency could be the US dollar.

Table 11.1: Economic Factors that Help in Selecting the Appropriate Functional Currency

Foreign Unit’s Local Currency Indicators Dollar Indicators
Cash Flows Primarily in the local currency; Direct impact on parent company; cash
do not directly affect parent flow available for remittance
company cash flows
Sales Prices Not responsive to exchange rate Determined more by world-wide
changes in the short run; competition; affected in the short run by
determined more by local exchange rate changes
conditions
Sales Market Active local market for entity’s Products sold primarily in the United
products States; sales contracts denominated in
dollars
Expenses Labour, materials, and other Inputs primarily from sources in the
costs denominated primarily in United States or otherwise denominated in
local currency dollars
Financing Primarily in local currency; Primarily from the parent company or
operations generate sufficient otherwise denominated in dollars;
funds to service these debts operations don’t generate sufficient dollars
to service its dollar debts
Intercompany Few intracorporate transactions; High volume of intracorporate
Transactions little connection between local transactions; extensive inter-relationship
and parent operations between local and parent operations

If the foreign affiliate’s functional currency is deemed to be the parent’s currency, translation of
the affiliate’s statements employs the temporal method of FAS 8. Thus, many US multinationals
continue to use the temporal method for those foreign affiliates that use the dollar as their
functional currency, while using the current rate method for their other affiliates. Under Fas 52,
if the temporal method is used, translation gains or losses flow through the income statement as
they did under FAS 8; they are not charged to the CTA account.

Notes Accounting exposure is the potential for translation losses or gains. Translation is
the measurement, in a reporting currency, of assets, liabilities, revenues, and expenses of
a foreign operation where the foreign accounts are originally denominated and/or
measured in a functional currency that is also a foreign currency. Accounting exposure is,
thus, the possibility that a change in exchange rates will cause a translation loss or gain
when the foreign financial statements are restated in the parent’s own reporting currency.

Self Assessment

Fill in the blanks:
6. If the …………………… affiliate’s functional currency is deemed to be the parent’s currency,
translation of the affiliate’s statements employs the temporal method of FAS 8.
7. According to FASB 52, firms must use the …………………… method to translate foreign
currency denominated assets and liabilities into dollars.

8. The …………………… currency is the currency in which the parent firm prepares its own
financial statements.

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