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4 pages/β‰ˆ1100 words
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Style:
APA
Subject:
Accounting, Finance, SPSS
Type:
Essay
Language:
English (U.S.)
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Topic:

Foreign Currency Exposure and Translation

Essay Instructions:

Albert, CEO of XYZ, Inc., desires to expand the company’s sales through exports to three foreign subsidiaries. Albert knows that the target subsidiaries' countries require transactions to be denominated in the local currencies. Albert has researched foreign currency risk and knows that there is accounting exposure in accounting statements, operating exposure in future cash flows, and transaction exposure in outstanding obligations. Albert does not understand how these risks apply to XYZ, Inc. under his proposal or if there are any mitigating risk strategies available.
Albert requests you, as head of the risk management division, to prepare a report that he can present to the board of directors on the potential foreign currency risk if XYZ, Inc. expands sales into these markets. XYZ, Inc.’s reporting currency is the U.S. dollar and the subsidiaries would purchase the merchandise as inventory items.
For more information on corporate strategies regarding hedging foreign exchange risk, refer to Chapter 9 of Advanced Accounting.
You may make any assumptions needed for the completion of this assignment.
Write a paper in which you:
Specify accounting exposure, operating exposure, and transaction exposure.
Determine the main financial statement effects of each type of exposure if XYZ, Inc. expands as proposed.
Determine two types of hedges regarding foreign exchange risk in general and recommend the most advantageous risk mitigation strategy for XYZ, Inc.
Provide support for your rationale.
Determine the main accounting assumptions underlying each currently used method (e.g., current rate method and temporal method).
Determine the fundamental differences in balance sheet exposure from the application of each method.
Suggest the translation method that XYZ, Inc. should use to minimize balance sheet exposure. Provide support for your choice.
Compare the U.S. GAAP approach to the IFRS approach of translating foreign currency financial statements.
Determine the main similarities and differences between the two methods of translation.
Assuming one of the subsidiaries of XYZ, Inc. is in a highly inflationary country, determine the appropriate translation method under FASB and provide the theoretical justification for your response.

Essay Sample Content Preview:

Foreign Currency Risk
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Unit Name & Number
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Foreign Currency Risk
Foreign currency risk or exchange rate risk refers to the financial risk that is induced by fluctuations in the value of a company's reporting currency against a foreign currency in that the firm holds financial assets or obligations. By expanding its operations through sales to foreign subsidiaries, XYZ Inc. will face foreign currency risks such as accounting, transaction, and operating exposures. That's because of the requirement that the subsidiaries prepare their books of accounts using the local currency of the countries where they operate. In the wake of such risks, the firm will need to place foreign currency risk mitigation measures to protect itself from the associated adverse impacts. According to Ito T. et al. (2016), firms with higher dependency on sales in foreign countries face higher foreign currency risk.
XYZ Inc.'s Accounting Exposure, Operating Exposure & Transaction Exposure
XYZ Inc. will face three categories of foreign currency exposure by operating foreign subsidiaries.
1 Accounting Exposure
Also known as translation or balance sheet exposure, accounting exposure arises when a parent company operates subsidiaries in foreign countries. Those subsidiaries are required by law to maintain their books of accounts in a monetary unit different from the Parent's home currency. XYZ Inc. potentially faces an accounting exposure risk because the target subsidiaries will report their financial transactions in other currencies. That means the consolidated financials will have to be translated to the Parent's reporting currency, impacting the profit(loss) reported due to foreign currency gains or losses.
2 Operating Exposure
Operating Exposure (n.d) describes operating Exposure as the extent to which a company's expected cash flows are impacted by foreign exchange fluctuations and inflation. XYZ's operating income might be adversely affected if a significant loss of value by the subsidiaries reporting currency against the US dollar. That will increase inflationary pressure making merchandise imports more expensive. The result will be in high direct costs related to inventories. A gain in value against the US dollar will have the opposite effect.
3 Transaction Exposure
This is a measure of the effect of forex fluctuations on the reporting currency's value of the firm's contractual cash flows that are denominated in foreign currency (Elbakyan, n.d). By operating foreign subsidiaries, the firm will have its foreign currency-dominated financial obligations or benefits exposed to gains or losses. Transaction exposure affects the cash flows and balance sheet items such as accounts receivable, accounts payable, cash and cash equivalents figures in the balance sheet.
Foreign Exchange Risk Hedging Options for XYZ Inc.
Gupta (2016) says that various financial instruments are available to a firm to manage its foreign exchange risks. These instruments include money market hedging techniques or currency derivatives like futures contracts, forward contracts, options, and swaps. Each instrument has several internal/external techniques that a firm can use to mitigat...
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