Question

Exposure to International Flow of Funds Ben Holt, chief financial officer (CFO) of Blades, Inc., has decided to counteract the decreasing demand for Speedos roller blades by exporting this product to Thailand. Furthermore, due to the low cost of rubber and plastic in Southeast Asia, Holt has decided to import some of the components needed to manufacture Speedos from Thailand. Holt feels that importing rubber and plastic components from Thailand will provide Blades with a cost advantage (the components imported from Thailand are about 20 percent cheaper than similar components in the United States). Currently, approximately $20 million, or 10 percent, of Blades’ sales are contributed by its sales in Thailand. Only about 4 percent of Blades’ cost of goods sold is attributable to rubber and plastic imported from Thailand. Blades faces little competition in Thailand from other U.S. roller blades manufacturers. Those competitors that export roller blades to Thailand invoice their exports in U.S. dollars. Currently, Blades follows a policy of invoicing in Thai baht (Thailand’s currency). Ben Holt felt that this strategy would give Blades a competitive advantage since Thai importers can plan more easily when they do not have to worry about paying differing amounts due to currency fluctuations. Furthermore, Blades’ primary customer in Thailand (a retail store) has committed itself to purchasing a certain amount of Speedos annually if Blades will invoice in baht for a period of 3 years. Blades’purchases of components from Thai exporters are currently invoiced in Thai baht. Ben Holt is rather content with current arrangements and believes the lack of competitors in Thailand, the quality of Blades’ products, and its approach to pricing will ensure Blades’ position in the Thai roller blade market in the future. Holt also feels that Thai importers will prefer Blades over its competitors because Blades invoices in Thai baht. You, Blades’ financial analyst, have doubts as to Blades’ “guaranteed” future success. Although you believe Blades’ strategy for its Thai sales and imports is sound, you are concerned about current expectations for the Thai economy. Current forecasts indicate a high level of anticipated inflation, a decreasing level of national income, and a continued depreciation of the Thai baht. In your opinion, all of these future developments could affect Blades financially given the company’s current arrangements with its suppliers and with the Thai importers. Both Thai consumers and firms might adjust their spending habits should certain developments occur. In the past, you have had difficulty convincing BenHolt that problems could arise in Thailand. Consequently, you have developed a list of questions for yourself, which you plan to present to the company’s CFO after you have answered them. Your questions are listed here: 1. How could a higher level of inflation in Thailand affect Blades (assume U.S. inflation remains constant)? 2. How could competition from firms in Thailand and from U.S. firms conducting business in Thailand affect Blades? 3. How could a decreasing level of national income in Thailand affect Blades? 4. How could a continued depreciation of the Thai baht affect Blades? How would it affect Blades relative to U.S. exporters invoicing their roller blades in U.S. dollars? 5. If Blades increases its business in Thailand and experiences serious financial problems, are there any international agencies that the company could approach for loans or other financial assistance?

Answer 1

Conducting business abroad poses multiple accounting challenges. Primary problems include the following:

• Accounting for sales made abroad and denominated in the foreign currency (Thai Baht).
• Accounting for assets held abroad, the value of which is denominated in foreign currency.
• Accounting for a foreign subsidiary that has to be consolidated in US corporation’s financial statements.
• Hedging in foreign currency to mitigate exposure to fluctuations in foreign currency.
• Accounting for intercompany transactions with a foreign subsidiary.
• Accounting for liabilities held abroad, the value of which is denominated in foreign currency.
• Accounting for purchases made abroad and denominated in foreign currency.

When US corporations conduct business abroad buying or selling of goods, these transactions are usually denominated in the currency of the place where the transaction takes place. For example, prices at McDonald’s in New York City are denominated in US Dollars but prices at McDonald’s in Bangkok are denominated in Thai Baht. Thus, a business may have multiple transactions involving various foreign currencies during the course of a year. However when preparing the financials, all of those transactions have to be converted to US$ because the reporting currency for a US company listed on any of the US Stock exchanges is US$.

A currency falls, weakens, relative to another currency if it takes more of that currency to purchase one unit of the other currency. A currency rises, or strengthens if it takes fewer units of that currency to purchase one unit of the other currency.

Inflation or an increase in prices over time is an important consideration in analyzing financial statements. These statements are based on historical costs usually and are not adjusted for the effects of increasing prices. Typically the sales revenue of a company increases over a year. However that does not necessarily guarantee that the company’s business is growing in real terms. For example, an increase in total sales from $200000 in one year to $210000 next year could be due to increase in the sales volume or an increase in the sales price. If it is the latter, and the company raised the selling price by 5% when the economy wide inflation was 8%, it is a good sign. In fact, it signifies a drop in the real economic price and did not result in a higher sales volume.