Page 194 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 11: Management of Translation Exposure

11.5 Keywords Notes

Current Rate Method: Under this method, all balance sheet and income items are translated at
the current rate of exchange, except for stockholders’ equity which is translated at historical rate.

FASB Statement No. 8: FASB Statement No. 8 provided that cash, receivables and payables were
translated at current exchange rates while fixed assets and liabilities were translated at historical
rates.
Forwards: A forward contract is one where counterparty agrees to exchange a specified currency
at an agreed price for delivery on a fixed maturity date.

Functional Currency: Functional currency is defined as the currency of the primary economic
environment in which the affiliate operates and in which it generates cash flows.
Monetary Items: Monetary items are those that represent a claim to receive or an obligation to
pay a fixed amount of foreign currency unit, e.g., cash, accounts receivable, current liabilities,
accounts payable and long-term debt.
Non-monetary Items: Non-monetary items are those items that do not represent a claim to
receive or an obligation to pay a fixed amount of foreign currency items, e.g., inventory, fixed
assets, long-term investments.

Reporting Currency: Reporting currency is the currency in which the parent firm prepares its
own financial statements.
Translation Exposure: Translation exposure (also known as accounting exposure) measures the
effect of an exchange rate change on published financial statements of a firm.

11.6 Review Questions

1. Briefly explain the four methods of translation exposure.
2. Write a note on the important features of FASB Rule 52.

3. Explain the difference in the translation process between the monetary/non-monetary
method and the current method.
4. Briefly explain the difference between ‘functional currency’ and ‘reporting currency’.
5. Identify the factors that help in selecting an appropriate functional currency that can be
used by an organisation.
6. What are the foreign currency translation methods used in other major developed
countries? Give three examples to illustrate your answer.

7. How are assets and liabilities translated under the current rate method?
8. What is accounting exposure?
9. How are assets and liabilities translated under the current rate method? Also, give the
advantages and disadvantages of this method.
10. Distinguish between functional and reporting currency.
11. Barrings Co. is a U.S. firm which annual export sales to Switzerland worth about $5400
million in Switzerland dollars (S$). Its main competitor is Nestle Co., also based in the
United States, with a subsidiary in Switzerland that generates about $2500 million in
annual sales. All earnings generated by the subsidiary are reinvested to support its
operations. Explain which of the two firms is subject to a higher degree of translation
exposure?

LOVELY PROFESSIONAL UNIVERSITY 189