Page 186 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 11: Management of Translation Exposure

All financial statement items restated in terms of the parent currency are the functional currency Notes
amount multiplied by the appropriate exchange rate. Table 11.2 compares the four translation
methods in terms of the exchange rate for each balance sheet item: current/non-current,
monetary/non-monetary, temporal and current rate.

Table 11.2: Exchange Rates Used to Translate Balance Sheet Items

Balance Sheet Current/Non-current Monetary/Non-monetary Temporal Current Rate
Cash C C C C
Receivables C C C C
Payables C C C C
Inventory C C C or H C
Fixed Assets H H H C
Long-term Debt H C C C
Net Worth H H H H

Example: Assume that a foreign subsidiary of a US multinational company has the
following:
(i) Cash = FC100 (ii) Account receivable = FC150 (iii) Inventory = FC200 (iv) Fixed assets = FC250
(v) Current liabilities = FC100 (vi) Long-term debt = FC300 and (vii) Net worth = FC300. Let us
further assume that the historical exchange rate is $2 = FC1, the current exchange rate is $1 = FC1
and inventory is carried at market prices.
Table 11.3 illustrates the effect of each translation method on the balance sheet. Exchange gains
or losses are shown here as a separate balancing account to show how they would be derived.
However, in actual practice, sometimes net worth is used as a balancing figure.
Under the current/non-current method, an exchange loss of $350 is recorded because current
assets are greater than current liabilities. On the other hand, under the monetary/non-monetary
method, an exchange gain of $150 is recorded because monetary liabilities exceed monetary
assets.

Table 11.3: Comparison of Four Translation Methods
Accounts Functional Current/Non- Monetary/Non- Temporal Current
Currency current monetary Rate
Cash FC 100 $100 (1) $100 (1) $100 (1) $100 (1)
Accounts 150 150 (1) 150 (1) 150 (1) 150 (1)
Receivable
Inventory 200 200 (1) 400 (2) 200 (1) 200 (1)
Fixed Assets 250 500 (2) 500 (2) 500 (2) 250 (1)
Total FC700 $950 $1150 $950 $700
Current FC100 $100 (1) $100 (1) $100 (1) $100 (1)
Liabilities
Long-term 300 600 (2) 300 (1) 300 (1) 300 (1)
Debt
Net Worth 300 600 (2) 600 (2) 600 (2) 600 (2)
Gains (Losses) – (350) 150 (50) (300)
Total FC 700 $950 $1150 $950 $700

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