MEASUREMENT OF TRANSLATION EXPOSURE

Translation exposure measures the effect of an exchange rate change on published financial statements of a firm.

· Assets & liabilities that are translated at the current exchange rate are considered to be exposed (uncovered) as the balance sheet will be affected by fluctuations in currency values over time.

· Assets & liabilities that are translated at a historical exchange rate will be regarded as not exposed as they will not be affected by exchange rate fluctuations.

· So, the difference between exposed assets & exposed liabilities is called translation exposure.

Translation exposure = Exposed assets- Exposed liabilities (change in the exchange rate)

Under the generally accepted US accounting principles, the net monetary asset position of a subsidiary is used to measure its parent’s foreign exchange exposure. The net monetary asset position is monetary assets such as cash & accounts receivable minus monetary liabilities such as accounts payable & long-term debt.

The translation of gains & losses does not involve actual cash flows – these gains or losses are purely on paper i.e. they are of an accounting nature.

STEPS for measuring translation exposure are:

1. Determine functional currency.

2. Translate using temporal method recording gains/losses in the income statement as realized

3. Translate using current method recording gains/losses in the balance sheet & as realized

4. Consolidate into parent company financial statements.