Why is translation exposure also referred to as accounting exposure? In what respects is translation exposure...

Why is translation exposure also referred to as accounting exposure? In what respects is translation exposure different from transaction exposure?

Expert Solution

Translation exposure is the risk that a company's equities, assets, liabilities or income will change in value as a result of exchange rate changes. This occurs when a firm denominates a portion of its equities, assets, liabilities or income in a foreign currency, and it's also known as "accounting exposure.”

Accountants use various methods to insulate firms from these types of risks, such as consolidation techniques for the firm's financial statements and the use of the most effective cost accounting evaluation procedures, and in many cases, this exposure will be recorded in financial statements as an exchange rate gain (or loss).

Translation exposure, also referred to as accounting exposure, measures the impact of exchangerate changes on the consolidated financial statements of a firm.
Multinational corporations have foreign subsidiary companies whose assets and liabilities aredenominated in foreign currencies that are exposed to translation risk; for example, if the foreignsubsidiary of an Australian company translates the value of its assets and liabilities into AUD atanything other than the fixed historical exchange rates at which the assets or liabilities wereinitially obtained, the AUD value of balance sheet will be affected.
A corporation needs to consider the accounting standards with which it must comply; forexample, within Australia, accounting standards requires corporations to consolidate their groupaccounts, including foreign subsidiaries, and recognise the value of assets and liabilities in AUDat other than the historical exchange rate.
A company must identify its net exposure by currency and its cross-currency exposures; forexample, a company may hold assets denominated in USD and at the same time have liabilitiesdenominated in JPY. The company will need to consider the relationship of the USD to the JPYin measuring its net FX exposure.

Transaction versus Translation Exposure

There is a distinct difference between transaction and translation exposure. Transaction exposure involves the risk that when a business transaction is arranged in a foreign currency, the value of that currency may change before the transaction is complete. Should the foreign currency appreciate, it will cost more in the business’ home currency. Translation risk focuses on the change in a foreign held asset’s value based on a change in exchange rate between the home and foreign currencies.

ekkarill92 answered 1 year ago

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