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
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.