Chapter 11
Translation
Exposure
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Key Focus Areas
1. What is
translation
exposure?
Its overview.
2. Methods 3. CLASS
Used while Translation PROBLEM TO
UNDERSTAND THE
Translating Exposure APPLICATION OF
Profits THE METHODS.
Balance Sheet
Hedging
(To be covered
during the
tutorials).
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Overview of Translation
Translation exposure, also called accounting exposure, arises because
financial statements of foreign subsidiaries – which are stated in foreign
currency – must be restated in the parent’s reporting currency for the
firm to prepare consolidated financial statements
The accounting process of translation, involves converting
these foreign subsidiaries financial statements into parent-
denominated statements
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Overview of Translation
Translation exposure is the potential for an increase or
decrease in the parent’s net worth and reported net income
caused by a change in exchange rates since the last
translation
While the main purpose of translation is to prepare consolidated
statements, management uses translated statements to assess
performance (facilitation of comparisons across many geographically
distributed subsidiaries).
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Overview of Translation
Why would we use a different
exchange rate in re-measuring
different line items?
Historic rates are applicable to when the items were acquired/ bought.
• Common stock
• Inventory (if mentioned in the problem that the rate applicable is pre
depreciation or appreciation then that is applicable)
• Fixed assets (net plant and machinery, equipment)
Current market rates to operational line items.
• Are applicable for all remaining line items (i.e. cash, accounts
receivables, bank loans, accounts payables)
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Translation methods
Two basic methods for the translation of foreign subsidiary
financial statements are employed worldwide:
The current rate method
The temporal method
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Current Rate Method
Gains or losses caused by translation adjustments are not included
in the calculation of consolidated net income
Rather, translation gains or losses are reported separately and
accumulated in a separate equity reserve account (on the B/S)
with a title such as cumulative translation adjustment (CTA).
The biggest advantage of the current rate method is that the gain
or loss on translation does not pass through the income statement
but goes directly to a reserve account (reducing variability of
reported earnings)
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Temporal Method
Under the temporal method, specific assets are translated at
exchange rates consistent with the timing of the item’s creation
This method assumes that a number of individual line item assets
such as inventory (to be marked at the date of acquisition or
historic rate) and fixed assets and common stock are restated to
(historic rate)
Gains or losses resulting from re-measurement are carried directly
to current consolidated income, and not to equity reserves
(increased variability of consolidated earnings)
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Translation Example: Trident Corporation - U.S. Multinational
Exhibit 11.2 shows Trident’s operating structure. Each subsidiary of Trident – the United States, Europe and China
– will have its own financial statement. Each set of financials will be constructed in the local currency (renminbi,
dollar and euros), but the subsidiary income statements and balance sheets will also be translated into U.S.
dollars, the reporting currency of the company.
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Translation methods – CHECK LIST
All items are translated at pre and
Current Rate Method
post rates.
The profit or loss is transferred to a
Common Stock/ Equity is translated
Equity Reserve Account.
at HISTORIC RATES.
Common Stock/ Fixed Assets is
translated at HISTORIC RATES.
Temporal Method
Inventory (if mentioned in the
The profit or loss is directly
problem that the rate applicable is
adjusted to the Income Statement.
pre depreciation or appreciation
then that is applicable).
Retained Earnings, are translated just as they were before appreciation or depreciation.
RULE OF THUMB. Thus, remains unchanged pre and post depreciation. You are to calculate
the unique exchange rate for Retained Earnings.
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Key Focus Areas
Agenda – Examine how the process of consolidation of a multinational firm's financial
results creates translation exposure.
Preliminary instructions:
• We will work on this problem during today’s session. Please form a group of two or
three members. (2minutes)
• Take out a piece of white paper and writing down names of your team members.
(2minutes)
• Now carefully, read the problem. (3minutes)
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Problem 11.8 – Reference : Text book
Bangkok Instruments, Ltd., is the Thai affiliate of a U.S. seismic instrument manufacturer.
Bangkok Instruments manufactures the instruments primarily for the oil and gas industry
globally, though with recent commodity price increases of all kinds -- including copper -- its
business has begun to grow rapidly. Sales are primarily to multinational companies based in
the United States and Europe. Bangkok Instruments' balance sheet in thousands of Thai
Baht's (B) as of March 31st is as follows.
Thai baht Thai baht
Assets statement Liabilities & Net Worth statement
Accounts payable ฿18,000
Cash ฿24,000 Bank loans 60,000
Accounts receivable 36,000 Common stock 18,000
Inventory 48,000 Retained earnings 72,000
Net plant & equipment 60,000 CTA account (loss) 0
Total ฿168,000 Total ฿168,000
Using the data presented, assume that the Thai baht dropped in value from B30/$ to B40/$
between March 31st and April 1st. Explain the translation gain or loss in terms of changes in
the value of exposed accounts. Historic rate is B20/$.
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Key Focus Areas
Agenda – Examine how the process of consolidation of a multinational firm's financial
results creates translation exposure.
Secondary instructions:
• List the suitable translation methods appropriate for this problem. (5minutes)
• Analyse and apply the appropriate exchange rates applicable based on two methods.
(10minutes)
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Key Focus Areas
Agenda – Examine how the process of consolidation of a multinational firm's financial
results creates translation exposure.
Final instructions:
• Please work on completing your work and comment on the appropriate outcome for
Bangkok Instruments. (15minutes)
• Please mark the work based on the answers provided. Comment wherever necessary
to indicate the muddy areas. (10 minutes)
• Please remember to hand in the sheets when leaving the class.
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Problem 11.8 – THE PROFORMA/ APPLICATION OF RATES
CURRENT RATE METHOD
Balance Sheet (thousands) Before Devaluation After Devaluation
Translated Translated
Thai baht Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars (Baht/US$) US dollars
Cash ฿24,000 30 $ 800 40 $ 600
Accounts receivable 36,000 30 1,200 40 900
Inventory 48,000 30 1,600 40 1,200
Net plant & equipment 60,000 30 2,000 40 1,500
Total ฿168,000 $ 5,600 $ 4,200
Liabilities & Net Worth
Accounts payable ฿18,000 30 $ 600 40 $ 450
Bank loans 60,000 30 2,000 40 1,500
Common stock 18,000 20 900 20 900
Retained earnings 72,000 34 2,100.00 34 2,100
CTA account (loss) 0 - $ (750)
Total ฿168,000 $ 5,600 $ 4,200
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WORKING NOTES
BALANCING FIGURE 1 (RETAINED EARNINGS – PRE DEVALUATION): Assets = Liabilities, i.e. $5,600.
Apply relevant rates for each line item for both Assets and Liabilities. Common stock (historic rate).
All remaining line items to be values at current market rate.
$ 5,600– (Sum of $600 + $2,000 + $900) = $2,100.
Transfer the amount to the Post devaluation column (as is).
CURRENT RATE METHOD
Balance Sheet (thousands) Before Devaluation
Translated
Thai baht Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars
Cash ฿24,000 30 $ 800
Accounts receivable 36,000 30 1,200
Inventory 48,000 30 1,600
Net plant & equipment 60,000 30 2,000
Total ฿168,000 $ 5,600
Liabilities & Net Worth
Accounts payable ฿18,000 30 $ 600
Bank loans 60,000 30 2,000
Common stock 18,000 20 900
Retained earnings 72,000 34 2,100.00
CTA account (loss) 0 -
Total ฿168,000 $ 5,600
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WORKING NOTES
BALANCING FIGURE 2 (CTA LOSS/ GAIN – POST DEVALUATION): Assets = Liabilities, i.e. $4,200.
Apply relevant rates for each line item for both Assets and Liabilities.
Common stock (historic rate).
All remaining line items to be values at current market rate.
Retained earnings (assuming the same amount is being sent to the parent unit for consolidation purposes).
$4,200 – (Sum of $450 + $1,500 + $900 + $2,100, RETAINED EARNINGS) = $750(CTA LOSS)
CURRENT RATE METHOD
Balance Sheet (thousands) After Devaluation
Translated
Thai baht Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars
Cash ฿24,000 40 $ 600
Accounts receivable 36,000 40 900
Inventory 48,000 40 1,200
Net plant & equipment 60,000 40 1,500
Total ฿168,000 $ 4,200
Liabilities & Net Worth
Accounts payable ฿18,000 40 $ 450
Bank loans 60,000 40 1,500
Common stock 18,000 20 900
Retained earnings 72,000 34 2,100
CTA account (LOSS/ GAIN) 0 $ (750)
Total ฿168,000 $ 4,200
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Problem 11.8
TRANSLATION BY THE CURRENT RATE METHOD
Balance Sheet (thousands) Before Devaluation After Devaluation
Translated Translated
Thai baht Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars (Baht/US$) US dollars
Cash ฿24,000 30 $ 800 40 $ 600
Accounts receivable 36,000 30 1,200 40 900
Inventory 48,000 30 1,600 40 1,200
Net plant & equipment 60,000 30 2,000 40 1,500
Total ฿168,000 $ 5,600 $ 4,200
Liabilities & Net Worth
Accounts payable ฿18,000 30 $ 600 40 $ 450
Bank loans 60,000 30 2,000 40 1,500
Common stock 18,000 20 900 20 900
Retained earnings 72,000 34 2,100 34 2,100
CTA account (loss) 0 - $ (750)
Total ฿168,000 $ 5,600 $ 4,200
This cumulative translation account (CTA) loss of $750,000 would be entered into the
company's consolidated balance sheet under equity.
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Problem 11.8 –THE PROFORMA/ APPLICATION OF RATES
TEMPORAL METHOD
Balance Sheet (thousands) Before Devaluation After Devaluation
Translated Translated
Thai baht Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars (Baht/US$) US dollars
Cash ฿24,000 30 $ 800 40 $ 600
Accounts receivable 36,000 30 1,200 40 900
Inventory 48,000 30 1,600 30 1,600
Net plant & equipment 60,000 20 3,000 20 3,000
Total ฿168,000 $ 6,600 $ 6,100
Liabilities & Net Worth
Accounts payable ฿18,000 30 $ 600 40 $ 450
Bank loans 60,000 30 2,000 40 1,500
Common stock 18,000 20 900 20 900
Retained earnings 72,000 23 3,100 23 3,100
Translation (Gain) 0 - $ 150
Total ฿168,000 $ 6,600 $ 6,100
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Problem 11.8
TRANSLATION BY THE TEMPORAL METHOD
Balance Sheet (thousands) Before Devaluation After Devaluation
Translated Translated
Thai baht Exchange Rate Accounts Exchange Rate Accounts
Assets Statement (Baht/US$) US dollars (Baht/US$) US dollars
Cash ฿24,000 30 $ 800 40 $ 600
Accounts receivable 36,000 30 1,200 40 900
Inventory 48,000 30 1,600 30 1,600
Net plant & equipment 60,000 20 3,000 20 3,000
Total ฿168,000 $ 6,600 $ 6,100
Liabilities & Net Worth
Accounts payable ฿18,000 30 $ 600 40 $ 450
Bank loans 60,000 30 2,000 40 1,500
Common stock 18,000 20 900 20 900
Retained earnings 72,000 23 3,100 23 3,100
Translation (Gain) 0 - $ 150
Total ฿168,000 $ 6,600 $ 6,100
The translation gain of $150,000 would be passed-through to the consolidated income
statement.
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