CHAPTER 10 MANAGEMENT OF TRANSLATION EXPOSURE
SUGGESTED ANSWERS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS
QUESTIONS
1. Explain the difference in the translation process between the monetary/nonmonetary method
and the temporal method.
Answer: Under the monetary/nonmonetary method, all monetary balance sheet accounts of a
foreign subsidiary are translated at the current exchange rate. Other balance sheet accounts
are translated at the historical rate exchange rate in effect when the account was first recorded.
Under the temporal method, monetary accounts are translated at the current exchange rate.
2. How are translation gains and losses handled differently according to the current rate
method in comparison to the other three methods, that is, the current/noncurrent method, the
monetary/nonmonetary method, and the temporal method?
Answer: Under the current rate method, translation gains and losses are handled only as an
adjustment to net worth through an equity account named the “cumulative translation
3. Identify some instances under FASB 52 when a foreign entity’s functional currency would be
the same as the parent firm’s currency.
Answer: Three examples under FASB 52, where the foreign entity’s functional currency will be
the same as the parent firm’s currency, are: i) the foreign entity’s cash flows directly affect the
parent’s cash flows and are readily available for remittance to the parent firm; ii) the sales prices
4. Describe the remeasurement and translation process under FASB 52 of a wholly owned
affiliate that keeps its books in the local currency of the country in which it operates, which is
different than its functional currency.
Answer: For a foreign entity that keeps its books in its local currency, which is different from its
functional currency, the translation process according to FASB 52 is to: first, remeasure the
5. It is, generally, not possible to completely eliminate both translation exposure and transaction
exposure. In some cases, the elimination of one exposure will also eliminate the other. But in
other cases, the elimination of one exposure actually creates the other. Discuss which
exposure might be viewed as the most important to effectively manage, if a conflict between
controlling both arises. Also, discuss and critique the common methods for controlling
translation exposure.
Answer: Since it is, generally, not possible to completely eliminate both transaction and
translation exposure, we recommend that transaction exposure be given first priority since it
There are two common methods for controlling translation exposure: a balance sheet
hedge and a derivatives hedge. The balance sheet hedge involves equating the amount of
exposed assets in an exposure currency with the exposed liabilities in that currency, so the net
exposure is zero. Thus when an exposure currency exchange rate changes versus the
PROBLEMS
1. Assume that FASB 8 is still in effect instead of FASB 52. Construct a translation exposure
report for Centralia Corporation and its affiliates that is the counterpart to Exhibit 10.6 in the text.
Centralia and its affiliates carry inventory and fixed assets on the books at historical values.
Solution: The following table provides a translation exposure report for Centralia Corporation
and its affiliates under FASB 8, which is essentially the temporal method of translation. The
difference between the new report and Exhibit 10.6 is that nonmonetary accounts such as
inventory and fixed assets are translated at the historical exchange rate if they are carried at
historical costs. Thus, these accounts will not change values when exchange rates change and
they do not create translation exposure.
Examination of the table indicates that under FASB 8 there is negative net exposure for
the Mexican peso and the euro, whereas under FASB 52 the net exposure for these currencies
is positive. There is no change in net exposure for the Canadian dollar and the Swiss franc.
Consequently, if the euro depreciates against the dollar from €1.1000/$1.00 to €1.1786/$1.00,
as the text example assumed, exposed assets will now fall in value by a smaller amount than
exposed liabilities, instead of vice versa. The associated reporting currency imbalance will be
$239,415, calculated as follows:
Reporting Currency Imbalance=
Translation Exposure Report under FASB 8 for Centralia Corporation and its Mexican and
Spanish Affiliates, December 31, 2013 (in 000 Currency Units)
Canadian
Dollar
Mexican
Peso Euro
Swiss
Franc
– €3,949,0000
€1.1786 / $1.00 – – €3,949,0000
€1.1000 / $1.00 = $239,415.
Assets
Cash CD200 Ps 6,000 € 825 SF 0
Accounts receivable 0 9,000 1,045 0
Inventory 0 0 0 0
2. Assume that FASB 8 is still in effect instead of FASB 52. Construct a consolidated balance
sheet for Centralia Corporation and its affiliates after a depreciation of the euro from
€1.1000/$1.00 to €1.1786/$1.00 that is the counterpart to Exhibit 10.7 in the text. Centralia and
its affiliates carry inventory and fixed assets on the books at historical values.
Solution: This problem is the sequel to Problem 1. The solution to Problem 1 showed that if the
euro depreciated there would be a reporting currency imbalance of $239,415. Under FASB 8
Note to instructor: Since Centralia and its affiliates carry inventory and fixed assets on the
Consolidated Balance Sheet under FASB 8 for Centralia Corporation and its Mexican and
Spanish Affiliates, December 31, 2013: Post-Exchange Rate Change (in 000 Dollars)
Centralia Corp.
(parent)
Mexican
Affiliate
Spanish
Affiliate
Consolidated
Balance
Sheet
Assets
Cash $ 950a$ 600 $ 700 $ 2,250
Accounts receivable 1,450b900 887 3,237
Inventory 3,000 1,500 1,500 6,000
Total assets $29,087
Liabilities and Net Worth
Accounts payable $1,800 $ 700b$1,157 $ 3,657
Notes payable 2,200 1,700 1,043e4,943
aThis includes CD200,000 the parent firm has in a Canadian bank, carried as $150,000.
CD200,000/(CD1.3333/$1.00) = $150,000.
b$1,750,000 – $300,000 (= Ps3,000,000/(Ps10.00/$1.00)) intracompany loan = $1,450,000.
3. In Example 10.2, a forward contract was used to establish a derivatives “hedge” to protect
Centralia from a translation loss if the euro depreciated from €1.1000/$1.00 to €1.1786/$1.00.
Assume that an over-the-counter put option on the euro with a strike price of €1.1393/$1.00 (or
$0.8777/€1.00) can be purchased for $0.0088 per euro. Show how the potential translation loss
can be “hedged” with an option contract.
Solution: As in example 10.2, if the potential translation loss is $110,704, the equivalent amount
in functional currency that needs to be hedged is €3,782,468. If in fact the euro does depreciate
to €1.1786/$1.00 ($0.8485/€1.00), €3,782,468 can be purchased in the spot market for
$3,209,289. At a striking price of €1.1393/$1.00, the €3,782,468 can be sold through the put
MINI CASE: SUNDANCE SPORTING GOODS, INC.
Sundance Sporting Goods, Inc., is a U.S. manufacturer of high-quality sporting goods–
principally golf, tennis and other racquet equipment, and also lawn sports, such as croquet and
badminton– with administrative offices and manufacturing facilities in Chicago, Illinois.
Sundance has two wholly owned manufacturing affiliates, one in Mexico and the other in
Canada. The Mexican affiliate is located in Mexico City and services all of Latin America. The
Canadian affiliate is in Toronto and serves only Canada. Each affiliate keeps its books in its
local currency, which is also the functional currency for the affiliate. The current exchange rates
are: $1.00 = CD1.25 = Ps3.30 = A1.00 = ¥105 = W800. The nonconsolidated balance sheets
for Sundance and its two affiliates appear in the accompanying table.
Nonconsolidated Balance Sheet for Sundance Sporting Goods, Inc. and Its Mexican and
Canadian Affiliates, December 31, 2013 (in 000 Currency Units)
Sundance, Inc.
(parent)
Mexican
Affiliate
Canadian
Affiliate
Assets
Cash $ 1,500 Ps 1,420 CD 1,200
Accounts receivable 2,500a2,800e1,500f
Inventory 5,000 6,200 2,500
Total assets $27,000 Ps21,620 CD10,800
Liabilities and Net Worth
Accounts payable $ 3,000 Ps 2,500aCD 1,700
Notes payable 4,000d4,200 2,300
worth
aThe parent firm is owed Ps1,320,000 by the Mexican affiliate. This sum is included in the
parent’s accounts receivable as $400,000, translated at Ps3.30/$1.00. The remainder of the
parent’s (Mexican affiliate’s) accounts receivable (payable) is denominated in dollars (pesos).
bThe Mexican affiliate is wholly owned by the parent firm. It is carried on the parent firm’s books
at $2,400,000. This represents the sum of the common stock (Ps4,500,000) and retained
earnings (Ps3,420,000) on the Mexican affiliate’s books, translated at Ps3.30/$1.00.
cThe Canadian affiliate is wholly owned by the parent firm. It is carried on the parent firm’s
books at $3,600,000. This represents the sum of the common stock (CD2,900,000) and the
retained earnings (CD1,600,000) on the Canadian affiliate’s books, translated at CD1.25/$1.00.
dThe parent firm has outstanding notes payable of ¥126,000,000 due a Japanese bank. This
sum is carried on the parent firm’s books as $1,200,000, translated at ¥105/$1.00. Other notes
payable are denominated in U.S. dollars.
eThe Mexican affiliate has sold on account A120,000 of merchandise to an Argentine import
house. This sum is carried on the Mexican affiliate’s books as Ps396,000, translated at
A1.00/Ps3.30. Other accounts receivable are denominated in Mexican pesos.
fThe Canadian affiliate has sold on account W192,000,000 of merchandise to a Korean
importer. This sum is carried on the Canadian affiliate’s books as CD300,000, translated at
W800/CD1.25. Other accounts receivable are denominated in Canadian dollars.
You joined the International Treasury division of Sundance six months ago after spending
the last two years receiving your MBA degree. The corporate treasurer has asked you to
prepare a report analyzing all aspects of the translation exposure faced by Sundance as a
MNC. She has also asked you to address in your analysis the relationship between the firm’s
translation exposure and its transaction exposure. After performing a forecast of future spot
rates of exchange, you decide that you must do the following before any sensible report can be
written.
a. Using the current exchange rates and the nonconsolidated balance sheets for Sundance and
b. i. Prepare a translation exposure report for Sundance Sporting Goods, Inc., and its two
affiliates.
c. Prepare a second consolidated balance sheet for the MNC using the exchange rates you
d. i. Prepare a transaction exposure report for Sundance and its affiliates. Determine if any