Translation Exposure

A 2 TRANSLATION EXPOSURE

Translation exposure is a type of foreign exchange risk faced by multinational corporations that have subsidiaries operating in another country. It is the risk that foreign exchange rate fluctuations will adversely affect the translation of the subsidiary’s assets and liabilities – denominated in foreign currency – into the home currency of the parent company when consolidating financial statements. Translation exposure is also called accounting exposure, or translation risk.

Translation exposure can affect any company that has assets or liabilities that are denominated in a foreign currency or any company that operates in a foreign marketplace that uses a currency other than the parent company’s home currency. The more assets or liabilities the company has that are denominated in a foreign currency, the greater the translation risk.

Ultimately, for financial reporting, the parent company will report its assets and liabilities in its home currency. So when the parent company is preparing its financial statements, it must include the assets and liabilities it has in other currencies. When valuing the foreign assets and liabilities for the purpose of financial reporting, all of the values will be translated into the home currency. Therefore foreign exchange rate fluctuations actually change the value of the parent company’s assets and liabilities. This is essentially the definition of accounting exposure.

In this case of Allied Lyons, translation exposure happen as a result of foreign affiliates’ ongoing operations when they are required to report to their shareholders on a quarterly basis their worldwide performance from both the parent firm and their foreign operations in the form of simple statistics – consolidated earnings and the much awaited and studied earnings-per-share. So, their financial results will have to be converted or translated from the foreign currency into the parent’s currency.

TRANSACTION EXPOSURE...