Question

Provide examples to illustrate balance sheet exposure and transaction exposure.

Answer 1

EXAMPLES OF BALANCE SHEET EXPOSURE ARE,balance sheet financing allows an entity to borrow being without affecting calculations of measures of indebtedness such as debt to equity (D/E) and leverage ratios low. Such financing is usually used when the borrowing of additional debt may break a debt covenant. The benefit of off balance sheet items is that they do not adversely affect the liquidity position of an entity.

balance sheet exposure items are in contrast to loans, debt and equity, which do appear on the balance sheet. Most commonly known examples of off-balance-sheet items include research and development partnerships, joint ventures, and operating leases

Among the above examples, operating leases are the most common examples of off-balance-sheet financing. In the case of operating leases, the asset itself is presented on the balance sheet of the lessor, and the lessee reports in its financial statements only the required rental expense paid against usage of the asset. International Financial Reporting Standards (IFRSs) have set numerous rules for the entities to follow in determining whether a lease should be classified as finance lease or operating lease.

Transaction exposure, defined as a type of foreign exchange risk faced by companies that engage in international trade, exists in any worldwide market. It is the risk that exchange rate fluctuations will change the value of a contract before it is settled.it is also called as transaction riskFor example, a domestic company signs a contract with a foreign company. The contract states that the domestic company will ship 1,000 units of product to the foreign company and the foreign company will pay for the goods in 3 months with 100 units of foreign currency. Assume the current exchange rate is: 1 unit of domestic currency equals 1 unit of foreign currency. The money the foreign company will pay the domestic company is equal to 100 units of domestic currency.