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.
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
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for the foreign entity’s products are responsive on a short-term basis to exchange rate changes,
where sales prices are determined through worldwide competition; and, iii) the sales market is
primarily located in the parent’s country or sales contracts are denominated in the parent’s
currency.
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
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
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of McGraw-Hill Education.
hedge is not really a hedge, but rather a speculative position, since the size of the “hedge” is
based on the future expected spot rate of exchange for the exposure currency with the reporting
currency. If the actual spot rate differs from the expected rate, the “hedge” may result in the
loss of real cash flows.
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
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.
Reporting Currency Imbalance=
Translation Exposure Report under FASB 8 for Centralia Corporation and its Mexican and
Spanish Affiliates, December 31, 2016 (in 000 Currency Units)
Canadian
Dollar
Mexican
Peso
Euro
Swiss
Franc
Assets
Cash
CD200
Ps 6,000
€ 825
SF 0
Accounts receivable
0
9,000
1,045
0
Inventory
0
0
0
0
Net fixed assets
0
0
0
0
Exposed assets
CD200
Ps15,000
€ 1,870
SF 0
Liabilities
Accounts payable
CD 0
Ps 7,000
€ 1,364
SF 0
Notes payable
0
17,000
935
1,400
Long-term debt
0
27,000
3,520
0
Exposed liabilities
CD 0
Ps51,000
€ 5,819
SF1,400
Net exposure
CD200
(Ps36,000)
(€3,949)
(SF1,400)
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
this is carried through the income statement as a foreign exchange gain to the retained earnings
Note to instructor: Since Centralia and its affiliates carry inventory and fixed assets on the
books at historical values, the monetary/monetary method (essentially IAS 21) will produce the
same translation.
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Consolidated Balance Sheet under FASB 8 for Centralia Corporation and its Mexican and
Spanish Affiliates, December 31, 2016: 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
1,450b
900
887
3,237
Inventory
3,000
1,500
1,500
6,000
Investment in Mexican
affiliate
–c
–
–
–
Investment in Spanish
affiliate
–d
–
–
–
Net fixed assets
9,000
4,600
4,000
17,600
Total assets
$29,087
Liabilities and Net Worth
Accounts payable
$1,800
$ 700b
$1,157
$ 3,657
Notes payable
2,200
1,700
1,043e
4,943
Long-term debt
7,110
2,700
2,987
12,797
Common stock
3,500
–c
–d
3,500
Retained earnings
4,190
–c
–d
4,190
Total liabilities and net
worth
$29,087
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.
c,dInvestment in affiliates cancels with the net worth of the affiliates in the consolidation.
eThe Spanish affiliate owes a Swiss bank SF375,000 (÷ SF1.2727/€1.00 = €294,649). This is
carried on the books, after the exchange rate change, as part of €1,229,649 = €294,649 +
€935,000. €1,229,649/(€1.1786/$1.00) = $1,043,313.
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
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, 2016 (in 000 Currency Units)
Sundance, Inc.
(parent)
Mexican
Affiliate
Canadian
Affiliate
Assets
Cash
$ 1,500
Ps 1,420
CD 1,200
Accounts receivable
2,500a
2,800e
1,500f
Inventory
5,000
6,200
2,500
Investment in Mexican
affiliate
2,400b
–
–
Investment in Canadian
affiliate
3,600c
–
–
Net fixed assets
12,000
11,200
5,600
Total assets
$27,000
Ps21,620
CD10,800
Liabilities and Net Worth
Accounts payable
$ 3,000
Ps 2,500a
CD 1,700
Notes payable
4,000d
4,200
2,300
Long-term debt
9,000
7,000
2,300
Common stock
5,000
4,500b
2,900c
Retained earnings
6,000
3,420b
1,600c
Total liabilities and net
worth
$27,000
Ps21,620
CD10,800
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of McGraw-Hill Education.
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
its affiliates, prepare a consolidated balance sheet for the MNC according to FASB 52.
b. i. Prepare a translation exposure report for Sundance Sporting Goods, Inc., and its two
affiliates.
ii. Using the translation exposure report you have prepared, determine if any reporting
currency imbalance will result from a change in exchange rates to which the firm has currency
exposure. Your forecast is that exchange rates will change from $1.00 = CD1.25 = Ps3.30 =
A1.00 = ¥105 = W800 to $1.00 = CD1.30 = Ps3.30 = A1.03 = ¥105 = W800.
c. Prepare a second consolidated balance sheet for the MNC using the exchange rates you
expect in the future. Determine how any reporting currency imbalance will affect the new
consolidated balance sheet for the MNC.
d. i. Prepare a transaction exposure report for Sundance and its affiliates. Determine if any
transaction exposures are also translation exposures.
ii. Investigate what Sundance and its affiliates can do to control its transaction and translation
exposures. Determine if any of the translation exposure should be hedged.
Suggested Solution to Sundance Sporting Goods, Inc.
Note to Instructor: It is not necessary to assign the entire case problem. Parts a. and b.i. can
be used as self-contained problems, respectively, on basic balance sheet consolidation and the
preparation of a translation exposure report.
Consolidated Balance Sheet for Sundance Sporting Goods, Inc. its Mexican and Canadian
Affiliates,
December 31, 2016: Pre-Exchange Rate Change (in 000 Dollars)
Sundance, Inc.
(parent)
Mexican
Affiliate
Canadian
Affiliate
Consolidated
Balance
Sheet
Assets
Cash
$ 1,500
$ 430
$ 960
$ 2,890
Accounts receivable
2,100a
849e
1,200f
4,149
Inventory
5,000
1,879
2,000
8,879
Investment in Mexican
affiliate
–b
–
–
–
Investment in Canadian
affiliate
–c
–
–
–
Net fixed assets
12,000
3,394
4,480
19,874
Total assets
$35,792
Liabilities and Net Worth
Accounts payable
$ 3,000
$ 358a
$1,360
$ 4,718
Notes payable
4,000d
1,273
1,840
7,113
Long-term debt
9,000
2,121
1,840
12,961
Common stock
5,000
–b
–c
5,000
Retained earnings
6,000
–b
–c
6,000
Total liabilities and net
worth
$35,792
b. i. Below is presented the translation exposure report for the Sundance MNC. Note, from the
report that there is net positive exposure in the Mexican peso, Canadian dollar, Argentine
Translation Exposure Report for Sundance Sporting Goods, Inc. and its Mexican and Canadian
Affiliates, December 31, 2016 (in 000 Currency Units)
Japanese
Yen
Mexican
Peso
Canadian
Dollar
Argentin
e
Austral
Korean
Won
Assets
Cash
¥ 0
Ps 1,420
CD 1,200
A 0
W 0
Accounts receivable
0
2,404
1,200
120
192,000
Inventory
0
6,200
2,500
0
0
Fixed assets
0
11,200
5,600
0
0
Exposed assets
¥ 0
Ps21,224
CD10,500
A120
W192,000
Liabilities
Accounts payable
¥ 0
Ps 1,180
CD 1,700
A 0
W 0
Notes payable
126,000
4,200
2,300
0
0
Long-term debt
¥ 0
7,000
2,300
0
0
Exposed liabilities
¥126,000
Ps12,380
CD 6,300
A 0
W 0
Net exposure
(¥126,000)
Ps 8,844
CD 4,200
A120
W192,000
b. ii. The problem assumes that Canadian dollar depreciates from CD1.25/$1.00 to
CD1.30/$1.00 and that the Argentine austral depreciates from A1.00/$1.00 to A1.03/$1.00. To
determine the reporting currency imbalance in translated value caused by these exchange rate
changes, we can use the following formula:
Net Exposure Currency i
S(i / reporting) – Net Exposure Currency i
S(i / reporting)
new old
= Reporting Currency Imbalance.
From the translation exposure report we can determine that the depreciation in the
Canadian dollar will cause a
CD4,200,000
CD1.30 / $1.00 – CD4,200,000
CD1.25 / $1.00 = –$129,231
reporting currency imbalance.
Similarly, the depreciation in the Argentine austral will cause a
A120,000
A1.03 / $1.00 – A120,000
A1.00 / $1.00 = –$3,495
reporting currency imbalance.
In total, the depreciation of the Canadian dollar and the Argentine austral will cause a
reporting currency imbalance in translated value equal to -$129,231 –$3,495= –$132,726.
c. The new consolidated balance sheet for Sundance MNC after the depreciation of the
Canadian dollar and the Argentine austral is presented below. Note that in order for the new
Consolidated Balance Sheet for Sundance Sporting Goods, Inc. its Mexican and Canadian
Affiliates,
December 31, 2016: Post-Exchange Rate Change (in 000 Dollars)
Sundance, Inc.
(parent)
Mexican
Affiliate
Canadian
Affiliate
Consolidate
d
Balance
Sheet
Assets
Cash
$ 1,500
$ 430
$ 923
$ 2,853
Accounts receivable
2,100a
845e
1,163f
4,108
Inventory
5,000
1,879
1,923
8,802
Investment in Mexican
affiliate
–b
–
–
–
Investment in Canadian
affiliate
–c
–
–
–
Net fixed assets
12,000
3,394
4,308
19,702
Total assets
$35,465
Liabilities and Net
Worth
Accounts payable
$3,000
$ 358a
$1,308
$ 4,666
Notes payable
4,000d
1,273
1,769
7,042
Long-term debt
9,000
2,121
1,769
12,890
Common stock
5,000
–b
–c
5,000
Retained earnings
6,000
–b
–c
6,000
CTA
–
–
–
(133)
Total liabilities and net
worth
$35,465
a$2,500,000 – $400,000 (= Ps1,320,000/(Ps3.30/$1.00)) intracompany loan = $2,100,000.
b,cThe investment in the affiliates cancels with the net worth of the affiliates in the consolidation.
dThe parent owes a Japanese bank ¥126,000,000. This is carried on the books as $1,200,000
(=¥126,000,000/(¥105/$1.00)).
eThe Mexican affiliate has sold on account A120,000 of merchandise to an Argentine import
house. This is carried on the Mexican affiliate’s books as Ps384,466 (= A120,000 x
Ps3.30/A1.03).
fThe Canadian affiliate has sold on account W192,000,000 of merchandise to a Korean
importer. This is carried on the Canadian affiliate’s books as CD312,000
(=W192,000,000/(W800/CD1.30)).
d. i. The transaction exposure report for Sundance, Inc. and its two affiliates is presented
below. The report indicates that the Ps1,320,000 accounts receivable due from the Mexican
Transaction Exposure Report for Sundance Sporting Goods, Inc. and
its Mexican and Canadian Affiliates, December 31, 2016
Affiliate
Amount
Account
Translation
Exposure
Parent
Ps1,320,000
Accounts
Receivable
No
Parent
¥126,000,000
Notes Payable
Yes
Mexican
A120,000
Accounts
Receivable
Yes
Canadian
W192,000,000
Accounts
Receivable
Yes
d. ii. Since transaction exposure may potentially result in real cash flow losses while translation
exposure does not have an immediate direct effect on operating cash flows, we will first address
the transaction exposure that confronts Sundance and its affiliates. The analysis assumes the
depreciation in the Canadian dollar and the Argentine austral have already taken place.
The parent firm can pay off the ¥126,000,000 loan from the Japanese bank using funds
from the cash account and money from accounts receivable that it will collect. Additionally, the
parent firm can collect the accounts receivable of Ps1,320,000 from its Mexican affiliate that is
Revised Translation Exposure Report for Sundance Sporting Goods, Inc. and its Mexican and
Canadian Affiliates, December 31, 2016 (in 000 Currency Units)
Japanese
Yen
Mexican
Peso
Canadian
Dollar
Argentine
Austral
Korean
Won
Assets
Cash
¥ 0
Ps 484
CD 1,512
A 0
W 0
Accounts
receivable
0
2,404
1,200
0
0
Inventory
0
6,200
2,500
0
0
Fixed assets
0
11,200
5,600
0
0
Exposed assets
¥ 0
Ps20,288
CD10,812
A 0
W 0
Liabilities
Accounts payable
¥ 0
Ps 1,180
CD1,700
A 0
W 0
Notes payable
0
4,200
2,300
0
0
Long-term debt
0
7,000
2,300
0
0
Exposed
liabilities
¥ 0
Ps12,380
CD6,300
A 0
W 0
Net exposure
¥ 0
Ps 7,908
CD4,512
A 0
W 0
Note from the revised translation exposure report that the elimination of the transaction
exposure will also eliminate the translation exposure in the Japanese yen, Argentine austral and
the Korean won. Moreover, the net translation exposure in the Mexican peso has been
reduced. But the net translation exposure in the Canadian dollar has increased as a result of
the Canadian affiliate’s collection of the won receivable.
The remaining translation exposure can be hedged using a balance sheet hedge or a
derivatives hedge. Use of a balance sheet hedge is likely to create new transaction exposure,