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IM-1CHAPTER10MANAGEMENTOFTRANSLATIONEXPOSURESUGGESTEDANSWERSANDSOLUTIONSTOEND-OF-CHAPTERQUESTIONSANDPROBLEMSQUESTIONS1.Explainthedifferenceinthetranslationprocessbetweenthemonetary/nonmonetarymethodandthetemporalmethod.Answer:Underthemonetary/nonmonetarymethod,allmonetarybalancesheetaccountsofaforeignsubsidiaryaretranslatedatthecurrentexchangerate.Otherbalancesheetaccountsaretranslatedatthehistoricalrateexchangerateineffectwhentheaccountwasfirstrecorded.Underthetemporalmethod,monetaryaccountsaretranslatedatthecurrentexchangerate.Otherbalancesheetaccountsarealsotranslatedatthecurrentrate,iftheyarecarriedonthebooksatcurrentvalue.Iftheyarecarriedathistoricalvalue,theyaretranslatedattherateineffectonthedatetheitemwasputonthebooks.Sincefixedassetsandinventoryareusuallycarriedathistoricalcosts,thetemporalmethodandthemonetary/nonmonetarymethodwilltypicallyprovidethesametranslation.2.Howaretranslationgainsandlosseshandleddifferentlyaccordingtothecurrentratemethodincomparisontotheotherthreemethods,thatis,thecurrent/noncurrentmethod,themonetary/nonmonetarymethod,andthetemporalmethod?Answer:Underthecurrentratemethod,translationgainsandlossesarehandledonlyasanadjustmenttonetworththroughanequityaccountnamedthe“cumulativetranslationadjustment”account.Nothingpassesthroughtheincomestatement.Theotherthreetranslationmethodspassforeignexchangegainsorlossesthroughtheincomestatementbeforetheyenterontothebalancesheetthroughtheaccumulatedretainedearningsaccount.IM-23.IdentifysomeinstancesunderFASB52whenaforeignentity’sfunctionalcurrencywouldbethesameastheparentfirm’scurrency.Answer:ThreeexamplesunderFASB52,wheretheforeignentity’sfunctionalcurrencywillbethesameastheparentfirm’scurrency,are:i)theforeignentity’scashflowsdirectlyaffecttheparent’scashflowsandarereadilyavailableforremittancetotheparentfirm;ii)thesalespricesfortheforeignentity’sproductsareresponsiveonashort-termbasistoexchangeratechanges,wheresalespricesaredeterminedthroughworldwidecompetition;and,iii)thesalesmarketisprimarilylocatedintheparent’scountryorsalescontractsaredenominatedintheparent’scurrency.4.DescribetheremeasurementandtranslationprocessunderFASB52ofawhollyownedaffiliatethatkeepsitsbooksinthelocalcurrencyofthecountryinwhichitoperates,whichisdifferentthanitsfunctionalcurrency.Answer:Foraforeignentitythatkeepsitsbooksinitslocalcurrency,whichisdifferentfromitsfunctionalcurrency,thetranslationprocessaccordingtoFASB52isto:first,remeasurethefinancialreportsfromthelocalcurrencyintothefunctionalcurrencyusingthetemporalmethodoftranslation,andsecond,translatefromthefunctionalcurrencyintothereportingcurrencyusingthecurrentratemethodoftranslation.5.Itis,generally,notpossibletocompletelyeliminatebothtranslationexposureandtransactionexposure.Insomecases,theeliminationofoneexposurewillalsoeliminatetheother.Butinothercases,theeliminationofoneexposureactuallycreatestheother.Discusswhichexposuremightbeviewedasthemostimportanttoeffectivelymanage,ifaconflictbetweencontrollingbotharises.Also,discussandcritiquethecommonmethodsforcontrollingtranslationexposure.Answer:Sinceitis,generally,notpossibletocompletelyeliminatebothtransactionandtranslationexposure,werecommendthattransactionexposurebegivenfirstprioritysinceitinvolvesrealcashflows.Thetranslationprocess,on-the-otherhand,hasnodirecteffectonreportingcurrencycashflows,andwillonlyhavearealizableeffectonnetinvestmentuponthesaleorliquidationoftheassets.IM-3Therearetwocommonmethodsforcontrollingtranslationexposure:abalancesheethedgeandaderivativeshedge.Thebalancesheethedgeinvolvesequatingtheamountofexposedassetsinanexposurecurrencywiththeexposedliabilitiesinthatcurrency,sothenetexposureiszero.Thuswhenanexposurecurrencyexchangeratechangesversusthereportingcurrency,thechangeinassetswilloffsetthechangeinliabilities.Tocreateabalancesheethedge,oncetransactionexposurehasbeencontrolled,oftenmeanscreatingnewtransactionexposure.Thisisnotwisesincerealcashflowlossescanresult.Aderivativeshedgeisnotreallyahedge,butratheraspeculativeposition,sincethesizeofthe“hedge”isbasedonthefutureexpectedspotrateofexchangefortheexposurecurrencywiththereportingcurrency.Iftheactualspotratediffersfromtheexpectedrate,the“hedge”mayresultinthelossofrealcashflows.IM-4PROBLEMS1.AssumethatFASB8isstillineffectinsteadofFASB52.ConstructatranslationexposurereportforCentraliaCorporationanditsaffiliatesthatisthecounterparttoExhibit10.7inthetext.Centraliaanditsaffiliatescarryinventoryandfixedassetsonthebooksathistoricalvalues.Solution:ThefollowingtableprovidesatranslationexposurereportforCentraliaCorporationanditsaffiliatesunderFASB8,whichisessentiallythetemporalmethodoftranslation.ThedifferencebetweenthenewreportandExhibit10.7isthatnonmonetaryaccountssuchasinventoryandfixedassetsaretranslatedatthehistoricalexchangerateiftheyarecarriedathistoricalcosts.Thus,theseaccountswillnotchangevalueswhenexchangerateschangeandtheydonotcreatetranslationexposure.ExaminationofthetableindicatesthatunderFASB8thereisnegativenetexposurefortheMexicanpesoandtheeuro,whereasunderFASB52thenetexposu