Tài chính doanh nghiệp - Management of translation exposure

10 MANAGEMENT OF TRANSLATION EXPOSURE CHAPTER ELEVEN TRANSLATION EXPOSURE • Changes in income statement items and the book value of balance sheet assets and liabilities that are caused by an exchange rate change. 1 2 • Current/noncurrent method: – current asset & liability are translated at the current ER – noncurrent asset & liability are translated at the historical ER – Most income statement items are translated at the average ER. ALTERNATIVE CURRENCY TRANSLATION METHODS 3 • Monetary/nonmonetary method – Monetary items (cash, account payables and receivable and long-term debt) are translated at the current rate – Nonmonetary items (inventory, fixed assets, and long – term investment) are translated at the historical rates – Income statement items are translated at average exchange rate during the period, except for revenue, and expense items related to nonmonetary assets and liability ALTERNATIVE CURRENCY TRANSLATION METHODS 24 • Temporal method – This method appears to be a modified version of monetary/non-monetary method. – The only difference: inventory is always translated at the current rate ALTERNATIVE CURRENCY TRANSLATION METHODS 5 • Current rate method – All balance sheet and income items are translated at the current rate ALTERNATIVE CURRENCY TRANSLATION METHODS 6 Assets Cash, market .securities Inventory (at market) Prepaid expenses total current assets Fixed asset - Dep. Goodwill Total assets Liabilities Current liabilities Longterm debt Deferred income taxes Total liabilities Capital stock Retained earnings Total equity Total liabilities+ equity Translation gain (loss) Monetary/Non Temporal Current/Noncurrent Current FINANCIAL STATEMENT IMPACT OF TRANSLATION ALTERNATIVE 7 FINANCIAL STATEMENT IMPACT OF TRANSLATION ALTERNATIVE Assets FC Cash, mar.securities 2,600 Inventory (at market) 3,600 Prepaid expenses 200 total current assets 6,400 Fixed asset - Dep. 3,600 Goodwill 1,000 Total assets 11,000 Liabilities Current liabilities 3,400 Long term debt 3,000 Deferred income taxes 500 Total liabilities 6,900 Capital stock 1,500 Retained earnings 2,600 Total equity 4,100 Total liabilities+ equity 11,000 Translation gain (loss) (FC4=$1) US$ 650 900 50 1,600 900 250 2,750 850 750 125 1,725 375 650 1,025 2,750 (FC 5=$1) Monetary Temporal Current/non Current rate US$ US$ US$ US$ 520 520 520 520 900 720 720 720 50 50 40 40 1,470 1,290 1,280 1,280 900 900 900 720 250 250 250 200 2,620 2,440 2,430 2,200 680 680 680 680 600 600 750 600 100 100 125 100 1,380 1,380 1,555 1,380 375 375 375 375 865 685 500 445 1,240 1,060 875 820 2,620 2,440 2,430 2,200 215 35 (150) (205) 38 FINANCIAL STATEMENT IMPACT OF TRANSLATION ALTERNATIVE Assets FC Cash, mar.securities 2,600 Inventory (at market) 3,600 Prepaid expenses 200 total current assets 6,400 Fixed asset - Dep. 3,600 Goodwill 1,000 Total assets 11,000 Liabilities Current liabilities 3,400 Longterm debt 3,000 Deferred income taxes 500 Total liabilities 6,900 Capital stock 1,500 Retained earnings 2,600 Total equity 4,100 Total liabilities+ equity 11,000 Translation gain (loss) (FC 2.5=$1) Monetary temporal Current/Non Current rate US$ US$ US$ US$ 1,040 1,040 1,040 1,040 900 1,440 1,440 1,440 50 50 80 80 1,990 2,530 2,560 2,560 900 900 900 1,440 250 250 250 400 3,140 3,680 3,710 4,400 1,360 1,360 1,360 1,360 1,200 1,200 750 1,200 200 200 125 200 2,760 2,760 2,235 2,760 375 375 375 375 5 545 1,100 1,265 380 920 1,475 1,640 3,140 3,680 3,710 4,400 (645) (105) 450 615 (FC4=$1) US$ 650 900 50 1,600 900 250 2,750 850 750 125 1,725 375 650 1,025 2,750 9 THE CURRENT TRANSLATION STANDARD IS FASB – 52 FOR US PARENT COMPANY • Foreign currency denominated assets and liabilities are translated in to dollars at current rate • A country which has experienced cumulative inflation of 100%, or more over a three year consecutive period is considered a hyperinflation country. In this case, the functional currency must be in US dollar • If the functional currency is the dollar, then subsidiary’s financial Statements in local currency must be re-measured in dollar using temporal method. The resulting translation gains and losses must be included in the income statement EXHIBIT 11.1 PROCEDURE FLOW CHART FOR UNITED STATES TRANSLATION PRACTICES ※ The term “remeasure” also means to translate. “Remeasure” is often used for the temporal method, and “translate” is often used for the current rate method (equivalent to self-sustaining subsidiary case) (equivalent to integrated subsidiary case) 11 412 FASB 52 TWO STAGE TRANSLATION PROCESS 13 TRANSLATION EXAMPLE: CARLTON GERMANY • In addition to creating a “before” and “after” translated balance sheet to calculate the translation exposure, there is a simpler method through multiplying the value of “net exposed assets” with the percentage of depreciation –An exposed asset (liability) is an asset (liability) whose value drops (rises) with the depreciation of the functional currency and rises (drops) with an appreciation of that currency –“Net” exposed assets means exposed assets minus exposed liabilities –The translation losses (gains) is a decrease (increase) of the value of net exposed assets –Exposed assets and liabilities for different translation methods are shown on the next slide TRANSLATION EXAMPLE: CARLTON GERMANY • The example of Carlton Germany is used to illustrate translation method – The following example deals with balance sheet only – The information of Carlton Germany is as follows • The functional currency is the euro, and the reporting currency of its parent company is the U.S. dollar • Plant, equipment, long-term debt are acquired at the EX rate of $1.2760/€ • Inventory on hand was purchased or manufactured during the last quarter when the average EX rate was $1.2180/€ • The spot EX rate is $1.2/€ today (Dec. 31, 2011) • When Carlton Germany reopened on Jan. 2, 2012, the euro had dropped 16.67% versus the dollar to be $1.0/€ • The inventory and the net plant and equipment are reported in their historical costs 516 Exhibit 12.4 Carlton Europe: Translation Loss Just After Depreciation of the euro December 31, 2011 January 2, 2012 In euros $/€ Just before Depreciation $/€ Just after Depreciation Current Rate Method Cash € 1,600,000 1 Accounts receivable 3,200,000 Inventory 2,400,000 Net plant and equipment 4,800,000 € 12,000,000 Accounts payable € 800,000 Short-term bank loan 1,600,000 Long-term debt 1,600,000 Common stock 1,800,000 Retained earnings 6,200,000 Translation gain (loss) --- € 12,000,000 Temporal Method Cash € 1,600,000 Accounts receivable 3,200,000 Inventory 2,400,000 Net plant and equipment 4,800,000 € 12,000,000 Accounts payable € 800,000 Short-term bank loan 1,600,000 Long-term debt 1,600,000 Common stock 1,800,000 Retained earnings 6,200,000 Translation gain (loss) --- € 12,000,000 17 Exhibit 12.4 Carlton Europe: Translation Loss Just After Depreciation of the euro December 31, 2011 January 2, 2012 In euros $/€ Just before Depreciation $/€ Just after Depreciation Monetary/Non monetary Method Cash € 1,600,000 Accounts receivable 3,200,000 Inventory 2,400,000 Net plant and equipment 4,800,000 € 12,000,000 Accounts payable € 800,000 Short-term bank loan 1,600,000 Long-term debt 1,600,000 Common stock 1,800,000 Retained earnings 6,200,000 Translation gain (loss) --- € 12,000,000 Current/non current Method Cash € 1,600,000 Accounts receivable 3,200,000 Inventory 2,400,000 Net plant and equipment 4,800,000 € 12,000,000 Accounts payable € 800,000 Short-term bank loan 1,600,000 Long-term debt 1,600,000 Common stock 1,800,000 Retained earnings 6,200,000 Translation gain (loss) --- € 12,000,000 MANAGING TRANSLATION EXPOSURE With funds adjustment, the MNCs changes either the amounts or currencies of planned cash flow of the parent and/or its affiliates • Direct funds adjustment deals with working capital adjustment • Indirect funds adjustment techniques include the use of transfer pricing and leading and lagging With forward contract are the most popular hedging instruments to manage translation exposure. However, leading and lagging of payables and receivables is almost at important Currency selection, transfer pricing, and exposure netting provide additional tools but are useless frequently due to constraints imposed on these techniques by the government When selecting the most appropriate hedging technique, firm should have their funds flow whenever it is profitable to do so on a covered basic regardless of its effect on translation exposure EXAMPLE: ZAPATA AUTO PART Zapata Auto Parts, the Mexican affiliate of American Diversified, Inc., had the following balance sheet on January 1: a. What is Zapata's FASB-52 peso translation exposure on January 1, translation exposure is measured using the temporal method? b. Suppose the exchange rate on December 31 is Mex. $ 8 (Mex$12). What will be Zapata's translation loss for the year? Assets (Mex$ millions) Liabilities (Mex$ millions) Cash, mar. securities 1,000 Current liabilities 47,000 A/receivable 50,000 Long – term debt 12,000 Inventory 32,000 Equity 135,000 Net fixed assets 111,000 Total assets 194,000 Liabilities + Equity 194,000